Owning a vacation home is a popular goal among homeowners. Whether the intent is to rent it out for additional income or to use it as your own private getaway, there are financial aspects of owning a vacation home that are important to consider. Vacation home purchases are expensive up front and can also incur large amounts in capital gains tax if you ever choose to sell the property. However, it is possible to defer taxes and save money by using a 1031 exchange in some cases.
A 1031 exchange is a special transaction that allows you to sell one investment property in “exchange” for another. This works by using part or all of the proceeds from the sale in obtaining the new investment property. This is a way for investors and sellers to save money on their taxes by deferring capital gains tax on any profits from the sale. The process is already complex, but for vacation homes there are additional rules that apply.
In order to be eligible for a 1031 exchange, you will need to make sure your vacation property follows all the IRS “safe harbor” rules. We can break those requirements down as:
You can only exchange “like-kind” properties. This is a requirement for all 1031 exchanges, regardless of the property type. It simply means that the property gained in the exchange must also be for investment long term.
The property must be used for “productive use” in business or for investment. This means the property generates income.
You have to own a property at least 2 years before exchanging it, or own the “replacement” property for at least 2 years after acquiring it.
In each of those two years, you must rent the property at fair market value for at least 14 days. Your personal use of the property must also be less than 14 days (or less than 10% of the time it was rented out, whichever is greater).
All of this means you will need to keep organized and detailed tax records for everything within that 2-year period. Make sure you can provide tax returns proving the income generated from the property and also record any time you spent personally in renovations, improvements, etc. Time spent working on the property does not count as your own “personal use” so carefully note the reasons for your visits.
If you mostly use your vacation home for personal use, it will probably not be eligible for a 1031 exchange. However, you might still save on taxes in other ways if you’re buying or selling. It all comes down to how long you own the home compared to the time you actually live in it. If you live in the property (“personal use”) for at least 2 of the previous 5 years, you can still exclude a fairly significant amount from your capital gains tax when you sell. If you purchased a property through a 1031 and later turned it into a personal residence, you can defer the exclusion as long as you live there for at least 5 years.
Timing is everything in determining whether you can buy or sell a vacation home through a 1031 exchange. Pursuing this kind of transaction takes lots of planning, organization and help from qualified professionals. If you’re unsure about whether your property or a property you want to buy will be eligible for a 1031, consult an expert.
I am a real estate broker, property manager, and investor, located in Ann Arbor, Michigan. To each client, I bring close to a decade of experience in real estate, first as a real estate investor, then manager, and now love to share my experience and knowledge with property buyers and sellers as a real estate broker. Since attending the University of Michigan in 2005, I have lived in Ann Arbor ever since. My exceptional knowledge of the market as an investor and property manager provides a unique perspective and competitive advantage to my clients for selling and buying both residential and investment properties.
I have successfully managed investment properties in Ypsilanti and Kalamazoo and have conducted real estate transactions throughout southeast Michigan. Whether clients are looking for their first home, vacation homes, or the home of their dreams, I will be able to stay on top of the process, remove obstacles and make the real estate deals as pleasurable as possible. I enjoy working with people and finding ways to share a laugh or two in the process. I take pride in being available to my clients and being responsive to their needs.
In addition to my residential property expertise, and my multicultural background, I am capable of working with international investors and home buyers to make their international property purchases smoother and trouble-free. If you are interested in the acquisition of investment homes for your children while they attend the University of Michigan, as a property manager, investor, and broker, I will be able to help you make that reality come true.
I graduated from the University of Michigan and own and operate several businesses in Ann Arbor and Ypsilanti. In addition to my real estate experience, I am also a technology enthusiast and am always on the hunt to use technology and media to enhance the buying and selling experience.
If you are looking to make your first home purchase, or are trying to sell your home, give me a call and I can guide you through the services that I can offer you to help you start along the journey. I take great pride in my work and it would be an honor for me to represent you and your needs.
Yours truly, Vincent Zhang