Special Rules for Vacation Homes

They say there is no escaping death and taxes, but in the case of vacation homes, there are a couple of ways to avoid tax when you are renting a home or selling it.  

 

Tax-Free Income

 

First, the IRS rules allow you to rent your vacation home for a short time period without having to pay any tax on the income.  If you rent your vacation home for 14 or fewer days, the rent is completely free from federal tax.  You don’t need to report the rental income, no matter how much you receive for it, as long as you don’t rent the property for more than 14 days per year.  

 

If you rent your vacation home for more than 14 days, you will need to report the income.  The rules about what’s taxable and what you can expense or deduct depend on how much you use the property and how much you rent it.  See IRS Publication 527 to determine what you need to do.  

 

Held for Investment Safe Harbor

 

Another tax break for vacation homes is a safe harbor that helps establish a home as being “held for investment purposes” so that you can either sell or buy it in a 1031 exchange.  

 

Properties exchanged in a 1031 exchange must be held for investment purposes or for use in your business.  Vacation homes that are used by the owner have a difficult time qualifying for an exchange because the owner must establish that the primary reason he owns the home is for investment, rather than personal, purposes.  The IRS created a guideline which says that if you follow the minimum ownership and rental, and maximum usage requirements, the property sold or acquired in an exchange will be deemed to be investment property.  

 

The guidelines set forth in the safe harbor are as follows:

 

Relinquished Property:

 

Relinquished property must be owned by the investor for the 24 months immediately prior to the exchange.  In each of the two consecutive 12 month periods prior to the exchange, (1) the investor must rent the property for at least 14 days at fair market value, and (2) the investor cannot use the property more than the greater of 14 days or 10% of the total number of days during the 12 month period that the property is rented at fair market value.

 

Replacement Property:

 

Replacement property must be owned by the investor for the 24 months immediately following the exchange.  In each of the two consecutive 12 month periods after the exchange, (1) the investor must rent the property for at least 14 days at fair market value, and (2) the investor cannot use the property more than the greater of 14 days or 10% of the total number of days during the 12 month period that the property is rented at fair market value.

 

It’s important to note that use by the taxpayer includes use by any owner and any family member of the taxpayer or owner.  

 

See Revenue Procedure 2008-16.