Author: Matthew Riley
PART 2 – The exchanger must intend to hold the replacement property (acquired property) for productive use in a trade or business or for investment purposes.
In Part 1 of this blog series about 1031 like-kind exchanges, we discussed a real estate investor’s relinquished property (the property an investor is selling), and the requirements such property must meet under Section 1031 to qualify for a like-kind exchange.
If an exchanger’s relinquished property meets Section 1031 requirements, then the next set of questions involve the replacement property, which we discuss, here, in Part 2.
One central inquiry is to investigate the exchanger’s intention in acquiring and using the replacement property. For an exchange to receive tax-deferred treatment, the exchanger must intend to predominantly use the replacement property in furtherance of a trade or business, or as investment property.
Many of the same issues raised in Part 1 about relinquished properties are the same for replacement properties. Therefore, our discussion about how requisite intent for relinquished property also applies for replacement property.
Here, in Part 2, I will focus attention on particular holding requirements for replacement properties, highlighting two things:
First, a safe-harbor provision for a specific and common type of replacement property––secondary and vacation homes; and secondly, specific requirements unique to replacement property, which the exchanger must meet when selecting such properties.
(a) Safe Harbor for replacement properties the exchanger intends to use as a second residence or vacation home?
The safe-harbor requirements for secondary residences or vacation homes are the same as I articulated for relinquished secondary or vacation homes. See Part 1.1. For these types of property, Revenue Procedure 2008-16 provides that if the exchanger meets its requirements it has established the requisite intent for the replacement property.
Under the safe-harbor requirements, the exchanger must own the home for two years immediately after the exchange, and for each of those years, or 12-month periods, the Exchanger must both:
(1) Rent the unit at a fair market rate for 14 or more days; AND
(2) Restrict their personal use to the greater of 14 days – OR – 10% of the number of days it was rented at a fair market rate within that 12 month period.
An investor must follow these requirements to defer their taxes under Section 1031.