GUIDANCE ON THE EXCHANGE OF VACATION HOMES VIA REVENUE PROCEDURE 2008-16

Feb, 2008 (comments added at bottom Feb, 2009)

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Guidance on the exchange of vacation homes via Revenue Procedure 2008-16 was provided recently by the Internal Revenue Service. This procedure was brought about as a result of last year's case in Tax Court Moore v. Commissioner, (T.C. Memo 2007-134) and a subsequent report by the Treasury Inspector General for Tax Administration that called for more IRS guidance on the subject. The revenue procedure creates a Safe Harbor for these exchanges; i.e., if an exchange is conducted in compliance with the parameters set forth, it will not be challenged. It is effective for exchanges commencing on or after March 10, 2008, which is also the date the procedure will be published in Internal Revenue Bulletin 2008-10.

IRS logo.jpgThe purpose of this revenue procedure is to create guidelines under which the taxpayer can establish that the property in question qualifies as held for investment, not simply owned for the personal use of the taxpayer with the hope for future appreciation.

Boiled down, the revenue procedure says that in order to qualify within the safe harbor, a dwelling unit, whether it is the relinquished property or the replacement property in the exchange (or both), must be owned by the taxpayer for at least 24 months before (in the case it is relinquished property) or after (in the case it is replacement property), and within each of the two 12-month periods immediately before and/or after the exchange: 1) The taxpayer rents the property to another person at fair market rent for 14 days or more, and 2) The taxpayer uses the property for personal use not more than the greater of 14 days or 10 percent of the number of days during the 12-month period that it is rented at fair market rent.

I realize that's a little cumbersome, but when does the government make things easy to understand? How about an example to clarify things some? You've owned a vacation home for three years. You put it on the market and it sells. Going backward from the date of sale (which is also the date your exchange begins), you did the following: 1) During the previous 12-month period, rented the property a total of 250 days at fair market rent and used it for personal use not more than 25 days (10% of the total days it was rented), and 2) During the 12-month period prior to that, rented the property only 100 days at fair market rent and used it for personal use not more than 14 days (the maximum allowable use given the fact that you only rented it for 100 days). If you can substantiate these facts in a satisfactory manner, this property falls within the safe harbor described above.

Food for thought. you own investment property today. You exchange out of your investment property into a vacation small.jpgvacation home that you operate within the safe harbor described above for two years. You then move into the vacation home as your personal residence. and live happily ever after?

Feb 2009 comments: The unstated implications in the final paragraph above were that capital gains could conceivably be turned into principal-residence-excluded gain under Section 121. While this can still be done, there are new limitations on the gain that can be excluded using such a strategy. It's still a viable plan, though! To understand those limitations, please see our blog article Converting Investment Property to Principal Residence? New Limits on Gain Exclusion!