The IRS has issued guidance that provides a safe harbor under which it will not challenge whether a dwelling such as a vacation home used partly for personal purposes is qualifying property for purposes of the like-kind exchange rules.
Generally, no gain or loss is recognized if property held for productive use in a trade or business or for investment (relinquished property) is exchanged solely for other property used in a trade or business or for investment (replacement property).
Personal residences do not qualify for like-kind exchange treatment notwithstanding an expectation of appreciation in value. However, many taxpayers hold property primarily for rental but occasionally use the property for personal purposes. The new guidance addresses these situations.
Under the new safe harbor, the IRS will not challenge whether relinquished property is held for productive use in a trade or business or investment if the dwelling unit is owned by the taxpayer for at least 24 months immediately prior to the exchange and, in each of the two 12-month periods immediately preceding the exchange (1) the taxpayer rents the dwelling unit to others at a fair rental value for at least 14 days and (2) the period of personal use does not exceed the greater of 14 days or 10% of the number of days that the unit is rented at fair rental value.
Similarly, the IRS will not challenge whether replacement property is held for productive use in a trade or business or investment if the dwelling unit is owned by the taxpayer for at least 24 months immediately after the exchange and, in each of the two 12-month periods immediately following the exchange (1) the taxpayer rents the dwelling unit to others at a fair rental value for at least 14 days and (2) the period of personal use does not exceed the greater of 14 days or 10% of the number of days that the unit is rented at fair rental value.
A dwelling unit is defined for purposes of this safe harbor as real property improved with a house, apartment, condominium or similar improvement that provides basic living accommodations including sleeping space, bathroom and cooking facilities.
Personal use is broadly defined and includes, among other things, use by family members (brothers and sisters, spouse, ancestors and lineal descendants) and, generally, rental to any other person at less than fair rental value. However, personal use does not include the rental for any period during which the tenant pays fair rental value and uses the dwelling unit as his or her principal residence.
The safe harbor applies only for purposes of determining whether dwelling units qualify as property held for productive use in a trade or business or for investment. All other like-kind exchange requirements must be satisfied.
The guidance is effective for exchanges effective after March 10, 2008. It states that no inference is intended with respect to the treatment of dwelling units occurring before that date.