Q: I currently own an apartment unit that I rent. I intend on selling the unit at a substantial profit, and plan to buy a vacation home. For the time being, I want to use the vacation home as a weekend get-away for part of the year, but otherwise I plan to hold it as a rental property. Doesn’t the tax law allow me to postpone being taxed on the net profits of my sale of the apartment unit if I use the proceeds to buy other real estate?
A: The Tax Code allows you to postpone your gain on the sale of the rental property if the property purchased with the proceeds meets the “like-kind exchange” rules.
In addition to certain other requirements, which are beyond the scope of this article, the transaction will only qualify as a “like-kind” exchange if the property sold was held for investment or use in your trade or business and, at the time of the exchange, you intend to hold the replacement property for investment or use in a trade or business.
A single-family home replacement property will meet the definition of being “held for investment” if, at the time of the transaction, the taxpayer intends exclusively to rent it to unrelated third parties. Conversely, ownership of the home will fail to meet this requirement if, at the time of the transaction, the taxpayer intends to use the property exclusively as a personal residence.
The answer becomes substantially trickier in your situation, where you intend to mix personal and rental use. Happily, the IRS has carved out a “safe harbor”; your use of the vacation home will be deemed to have had the requisite investment intent if you can satisfy certain criteria, summarized here:
- Minimum holding period: You must hold the vacation home for at least two years following the exchange.
- Minimum rental period: You must rent out the property for at least 14 days during each year of the two-year minimum holding period.
- Maximum personal use period: During each year of the two-year minimum holding period, you may not use the home as a personal residence for more than the combined total of the greater of:
- 14 days or
- 10% of the number of rental days
- Please consult your tax advisor for further guidance, especially if you are considering renting to relatives or have questions relating to rental agreement terms.
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. We recommend that you consult a lawyer for guidance specific to your particular situation.