Can You Use a 1031 Exchange for a Vacation Home at the Jersey Shore?

Yes, if the home works as a rental property that you also use now and then, and no, if it's a vacation home you only use yourself. The IRS safe harbor in Revenue Procedure 2008-16 covers a home owned at least 24 months and rented at a fair rental for 14 days or more, with personal use kept to the greater of 14 days or 10% of the rented days, in each of the two 12-month periods before the exchange.

I'm Dennis Mark Interdonato with The Dennis Mark Group at Keller Williams Realty Ocean Living. If you own a second home at the shore in Monmouth or Ocean County that you use some weeks and rent others, this is the rule that decides whether a 1031 exchange is even on the table, and it's worth knowing before you list.

What is a 1031 exchange?

The IRS explains that when you exchange real property used for business or held as an investment solely for like-kind business or investment property, you generally aren't required to recognize a gain or loss under Section 1031. If you also receive money or other property, you recognize gain to that extent.

Since January 1, 2018, it's real estate only. The IRS says the Tax Cuts and Jobs Act limited like-kind exchanges to real property held for use in a trade or business or for investment. Real property held primarily for sale still doesn't qualify, and U.S. real estate isn't like-kind to real estate outside the country.

Is a vacation home an investment property?

Not if you only use it yourself. In Rev. Proc. 2008-16, the IRS points to its earlier guidance that Section 1031 "does not apply to property that is used solely as a personal residence." It also cites a Tax Court case about two lakeside vacation homes that were never rented, where the court held that the "mere hope or expectation that property may be sold at a gain cannot establish an investment intent if the taxpayer uses the property as a residence."

Then it addresses the middle ground: "The Service recognizes that many taxpayers hold dwelling units primarily for the production of current rental income, but also use the properties occasionally for personal purposes." The safe harbor is written for those homes.

What does the IRS safe harbor require?

For the home you're giving up, Rev. Proc. 2008-16 says it qualifies if:

• "The dwelling unit is owned by the taxpayer for at least 24 months immediately before the exchange"; and
• in each of the two 12-month periods immediately before the exchange, "The taxpayer rents the dwelling unit to another person or persons at a fair rental for 14 days or more"; and
• "The period of the taxpayer's personal use of the dwelling unit does not 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 rental."

The home you're getting has to pass the same tests for the 24 months after the exchange. If you report an exchange expecting the new home to qualify and it doesn't, the IRS says you should file an amended return, if necessary.

Here's how the personal-use limit works. Rent the house at a fair rental for 120 days in a 12-month period, and 10% is 12 days, so the limit is the greater number: 14 days. Rent it for 200 days, and the limit is 20 days. What counts as personal use and a fair rental are calls for your CPA.

Meet the standards, and the IRS says it "will not challenge" whether the home counts as business or investment property. That's all the safe harbor settles: every other 1031 requirement still applies, and outside the standards, your CPA and attorney decide.

What are the 45-day and 180-day deadlines?

When the new property comes after the sale, the IRS calls it a deferred exchange, and the Form 8824 instructions set two clocks:

• The replacement property "must be identified within 45 days" after you transfer the property you're giving up, in writing, described clearly, such as by legal description or street address.
• It "must be received within 180 days, or by the due date of your tax return (including extensions), whichever is earlier."

The instructions also cover qualified intermediaries and the special rules for exchanges with related parties. Those clocks start when your current home transfers, so I'd start looking at replacement property before your current home goes on the market.

How do you report a 1031 exchange?

On Form 8824, Like-Kind Exchanges, filed with your tax return for the year you transferred property in the exchange. The IRS says the form figures the gain deferred and the basis of the property you received when cash or other property is involved. If the home you gave up was used partly as your main home, the instructions call for two worksheet Forms 8824, one for each part.

What does New Jersey require at closing?

A seller who doesn't live in New Jersey normally makes an estimated income tax payment when the deed is recorded. The NJ Division of Taxation's Form GIT/REP-3 lets a seller claim an exemption when "The gain from the sale is not recognized for federal income tax purposes under 26 U.S. Code section 721, 1031, or 1033."

The instructions add conditions. A nonresident claiming it must show the value of the like-kind property received, and if the exchange doesn't fully qualify, the seller files a New Jersey return and reports the gain. If cash or other non-like-kind property is part of the deal, the seller can pay 2% of the nonexempt amount at recording or make an estimated payment afterward. If a deferred exchange is voided, the qualified intermediary remits 2% of the total consideration.

What does this mean for a Jersey Shore second home?

Before you list, pull together what your CPA will ask for:

• the date you bought the home, so you know whether you've owned it 24 months;
• rental records for each of the last two 12-month periods: dates, rents and leases;
• a calendar of the days the home was used personally;
• your town's rental registration or permit, if it requires one; and
• what you'd buy next, and how you'd use it for the two years after.

For the rental side, read renting out a Jersey Shore second home: NJ taxes and fees and second home or investment property. For financing, see home loans for investors vs. primary residences. If the replacement is here at the shore, I'll walk it with you with a former New Jersey home builder's eye.

Start with what your current home is worth on my home value tool, see the luxury homes page, and get my free Luxury & Waterfront Guide.

Frequently Asked Questions

Can I do a 1031 exchange on a vacation home I've never rented?

The IRS guidance says Section 1031 doesn't apply to property used solely as a personal residence, and a home that's never rented can't meet the safe harbor's rental test. Ask your CPA where that leaves you.

How many days can I use my shore house and still fit the safe harbor?

No more than the greater of 14 days or 10% of the days it's rented at a fair rental, in each of the two 12-month periods.

Can the replacement property be a home I'll use myself?

It has to be held for business or investment too. Under the safe harbor, that means owning it 24 months after the exchange and meeting the same rental and personal-use tests.

This is general information, not legal, tax or lending advice. Whether an exchange qualifies is decided by your CPA and attorney, under the IRS rules and your facts.

About the author

Dennis Mark Interdonato is a REALTOR® and Master CDRE® who leads The Dennis Mark Group at Keller Williams Realty Ocean Living in Point Pleasant, NJ, helping buyers and sellers throughout New Jersey make their next move, with Monmouth and Ocean County as home base. He has been in construction since 2003, building and renovating New Jersey homes. Read more about Dennis Mark.

Keep reading

• Buying a second home at the Jersey Shore: second home or investment property?
• Renting out a Jersey Shore second home: NJ taxes and fees
• Short-term rental vs. long-term rental in New Jersey
• Have a question this didn't answer? Send it to Dennis Mark and it may become the next article.