Atlanta Deferred Exchange
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Atlanta Deferred Exchange

My vacation home has appreciated substantially. Can I use a 1031 exchange when I sell it?

Q:  Several years ago, my husband and I bought a house in the mountains that we hoped would appreciate in value.  During the time we've owned it, our family visits it monthly, and we also allow friends to stay there occasionally.  Since it is now worth nearly twice what we paid for it, we'd like to sell it and exchange into another investment property nearby.  Can we do this with a 1031 exchange?

A:  Succinctly, no.  To be eligible for the tax deferral under Section 1031, a property must be held for productive use in a trade or business or for investment.  Though your second home may have proved a wise "investment", it will not be viewed as investment property by the IRS.  The way you demonstrated your intent- investment or 2nd home- will need to be shown in both your actions, as well as how your report the purchase and related costs on your tax return.  As it appears you did not seek to or actually rent it out, but rather used it as a 2nd home or personal retreat, it will not meet the requirements of qualified property.

One caveat: you can use an investment property for limited personal use and have it still qualify for 1031 treatment.  There are personal-use rules for investment property which state that the period of the taxpayer's personal use of the dwelling unit cannot exceed the greater of 14 days or 10 percent of the number of days during the 12-month period that the dwelling unit is rented at a fair market value. So, as long as you rent out a resort property, account for it correctly on your tax return, and limit your use according to the rules, you can have a bite of your cake and eat it too.