As we covered in our previous article, 1031 Exchange is an important program that allows property owners to defer paying capital gains taxes when selling one investment property to buy another. In Massachusetts, vacation homes are popular along the Cape and other seaside communities. Do vacation homes qualify for 1031 exchanges? The answer is, it depends.

Which Vacation Homes Qualify for 1031 Exchanges

The term “vacation home” may apply to different types of properties. First, there’s the second home that you may keep and visit every weekend. It is used exclusively for you and your family. It is an investment in the sense that you hope it will increase in value over time, but you actively use it as just a private home. Unfortunately, such properties are considered for personal use and do not qualify for a 1031 Exchange.

The other type of vacation home is one that you may rent out when you’re not using it yourself. This is more in line with the definition of an investment property since it is actually used to generate income. Under certain conditions, these types of vacation homes qualify for 1031 exchanges.

Qualification Criteria

Vacation homes qualify for 1031 exchanges if they meet the following criteria:

  1. You must own it for at least 2 years prior to the exchange date.
  2. Within each year of the 2 preceding years,..
    • The property must have been rented for 14 or more days.
    • The property must have been rented for fair market value.
    • You, as the owner, must not have occupied the property yourself for more than 14 days or 10% of the number of days it was rented to someone else, whichever is higher.

This applies to the property that you are selling. If you are exchanging this property for another vacation home, then that new home must also meet the same criteria. You must own it for at least 2 years after purchasing it, rent it for fair market value at least 14+ days each year (for those two years), and not occupy it yourself beyond the limits noted above.

Planning Ahead Is Key

1031 Exchanges can save you significant money on the sale and purchase of investment properties. It’s a great idea to use it for vacation homes, especially if you’re looking to sell one vacation home to buy another. The key is to plan ahead. It’s essentially a 4-year plan since you must comply with the above guidelines 2 years before selling your existing vacation home and 2 years after buying the new one. Once that timeframe has lapsed, you can convert the new vacation property back to personal use and pay capital gains taxes when you eventually sell that new home. To learn more about how vacation homes qualify for 1031 exchanges, consult with your attorney or give us a call. We are happy to represent home buyers and home sellers in the purchase and sale of vacation homes in Massachusetts.