Dear John,
A few years back, I bought a second home purely for me and my family to use. It’s been the perfect weekend escape, but now I’m thinking about selling and I’m staring down a pretty sizable capital gains tax bill. I’ve heard about 1031 exchanges as a way to defer those taxes, but since this was just a personal-use property, I assume I’m out of luck. Is there a way to make this work?
-Hopeful in High Country
Dear Hopeful,
You’re not alone. This is a question I hear all the time, especially from folks who bought vacation homes before the boom and are now sitting on serious appreciation. The short answer? With a little bit of planning and patience, there is a way forward.
A 1031 exchange only applies to investment or business-use property. Unfortunately, vacation homes and second homes used solely for personal enjoyment are specifically excluded. But here’s the good news: resort rentals are not.
In fact, the IRS gave us a helpful playbook in Revenue Procedure 2008-16. It outlines a “safe harbor” that allows you to convert your vacation home into a property eligible for a 1031 exchange as long as you meet some clear standards. To make the property qualify:
- Rent it out — You must rent the property at fair market value to an unrelated person for at least 14 days per year for two years before you sell.
- Limit your own use — Your personal use must not exceed the greater of 14 days or 10% of the time it’s rented during those same years.
- Plan ahead — This is not a retroactive fix. You’ll need to show the IRS that your intent and use match these standards over time.
If you’re willing to follow these steps, you could successfully convert a personal-use home into a qualifying investment property and use a 1031 exchange to defer your capital gains tax. It does require some forethought, but the tax savings could be well worth the effort. If you’re curious whether this could work for you, give us a call at (864) 679-4793.