Vacation homes that are not held strictly for investment purposes do not qualify for like-kind exchange treatment under Code Sec. 1031.  The Tax Court recently ruled that just because a vacation property will increase quickly in value does not make it “an investment” for purposes of qualifying it for like-kind exchange treatment. Especially if the owner uses the property for a significant period of time and doesn’t rent the property, it’s hard to make the “investment” label stick.

In the recent case, the Tax Court held that the exchange of vacation home properties, one for another, will not qualify for tax-free like-kind treatment under Code Sec. 1031 if the properties are not held primarily for use in a trade or business, or for investment purposes. Even if the residence is held in part by an expectation that the property’s value will appreciate, the motivation is insufficient to qualify the exchange for tax-deferred treatment under Code Sec. 1031. The mere expectation or hope that the property will be sold at a gain will not establish an “investment intent” if the taxpayer is using the property as a residence.

Primary purpose

The Tax Court set out some guidelines if you plan to maximize the tax laws on any vacation property that you own.  If the primary purpose in acquiring and holding the properties was to enjoy use of the properties as vacation homes, or secondary residences, the property is not held for investment purposes. Evidence that the property is used as a vacation retreat, personal improvements are made, neither the new or old property is rented out, and no claims for depreciation or investment interest expenses are made will signal that the property is used for personal purposes rather than investment. Personal use of property is not compatible with treating it as “held for investment” under Code Sec. 1031.

As the Tax Court stated, “The holding of a primary or secondary (e.g. vacation) residence motivated in part by an expectation that the property will appreciate in value is insufficient to justify the classification of that property as property ‘held for investment’ under Code Sec. 212(2) and, by analogy, Code Sec. 1031.”

(Moore, TC Memo 2007-134)