The key to a legal and acceptable 1031 exchange activity is to have the right time and be clear about all the requirements from the beginning. Especially with Congress considering the future of 1031 exchanges right now, it’s a good idea to network with a qualified broker to determine next steps for you. Being deliberate and measured in your approach is important to meeting the requirements and obtaining all the possible benefits of going ahead with the 1031 exchange.
One of the most common questions about 1031 exchanges has to do with primary residences or vacation homes. It is important to know that you can convert a primary residence to a vacation home in a way that meets the 1031 guidelines, but this property must be rented and not just held. Property must be rented for a period of time and must be rented for most of any year. If the property is not used for business or investment purposes, it does not technically qualify for a 1031 exchange.
If you went ahead with a trade and later found that the property was not suitable, you would be responsible for paying capital gains taxes. This is why understanding and selecting the right properties is important from the start.
If a 1031 is being made on a primary residence that has been converted to a vacation rental, the safe harbor rule comes into play. This means that the new home must be rented for more than 14 days in each of the two years prior to the purchase date. This also means that you cannot live there more than 14 days a year, or more than 10 percent of the total number of rental days for that property.
Make sure you are clear about these rules and that you have hired a qualified broker as soon as possible when you are ready to go ahead with the exchange. The qualified intermediary is the third party who accepts the funds from the sale of the first property and holds them on your behalf until they are used to purchase the second property. It may seem like a minor detail, but it is very important that you use a qualified broker for your exchange. Not only does it ensure that you have followed the rules to the letter, but it can also be very helpful to have an experienced professional guide you through the process.