1. To postpone gain on the sale of a rental property and purchase a vacation home, the replacement property must meet the “like-kind exchange” rules in the Tax Code.
2. The replacement property must be held for investment or use in the taxpayer’s trade or business at the time of the exchange, and the taxpayer must intend to hold the replacement property for investment or use in a trade or business.
3. If the taxpayer intends to rent the replacement property to unrelated third parties exclusively, it will meet the “held for investment” requirement.
4. If the taxpayer intends to use the property exclusively as a personal residence, it will fail to meet the “held for investment” requirement.
5. If the taxpayer plans to use the vacation home for both personal and rental use, there is a “safe harbor” provision that deems the use to have had the requisite investment intent if certain criteria are met.
6. The vacation home must be held for at least two years following the exchange, and it must be rented out for at least 14 days during each year of the two-year minimum holding period. 1. During each year of the two-year minimum holding period, the homeowner may not use the home as a personal residence for more than the combined total of 14 days or 10% of the number of rental days, whichever is greater.
2. Homeowners should consult a tax advisor for further guidance, especially if they are considering renting to relatives or have questions relating to rental agreement terms.
3. Know the Law is a bi-weekly column sponsored by McLane Middleton. Questions and ideas for future columns should be emailed to knowthelaw@mclane.com. Know the Law provides general legal information, not legal advice. It is recommended to consult a lawyer for guidance specific to a particular situation.
Know the Law: Making Your Vacation Home Purchase a Tax-Favored Transaction
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