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William Horan

Vacation Home Revenue Procedure 2008-16

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Safe Harbor for Vacation Home

The IRS published Revenue Procedure 2008-16 for the purpose of providing a Safe Harbor under which the IRS will not challenge whether a dwelling unit with limited personal use qualifies as property held for productive use in a trade or business or for investment for purposes of Section 1031 of the Internal Revenue Code.

Dwelling Unit

For this Revenue Procedure, a dwelling unit is real property improved with a house, apartment, condominium, or similar accommodations including sleeping space, bathroom, and cooking facilities. The Revenue Procedure says, “The Service recognizes that many taxpayers hold dwelling units primarily for the production of current rental income, but that they also use the properties occasionally for personal purposes.” This Revenue Procedure applies to the exchange of dwelling units occurring on or after March 10, 2008.

Qualifying Use

The Qualifying Use Standards established in Section 4 of the Revenue Procedure are new. If the standards are met, the IRS will not challenge whether the dwelling unit is held for a qualifying use in an exchange. The Qualifying Use Standards are applied to either the relinquished property or the replacement property and are:

a) that the dwelling unit with limited personal use is owned at least 24 months before the exchange if it’s the relinquished property, or 24 months after the exchange if it’s the replacement property;

b) that, within the applicable 24-month qualifying use period, in each of the two 12-month periods, the taxpayer rents the dwelling unit to another unrelated person or persons at fair value rental for 14 days or more. A related person may rent at fair value if the dwelling is a principal residence for the related person (§§280A(d)(2) & 280A(d)(3)), and

c) that the property must be a dwelling unit.

A taxpayer utilizing the Safe Harbor in this Revenue Procedure also must satisfy all other requirements for a like-kind exchange under Section 1031 and the regulations thereunder.

Each Property

If you want to use the Safe Harbor, the Revenue Procedure looks at each property to determine if personal use is too high and if actual rental income is generated. If you have a relinquished dwelling with personal use, we now know that if you wish to use the safe harbor, you should own it 2 years before an exchange, rent it to someone other than direct family at fair value for at least 14 days in each of the 2 years, and limit personal use to 14 days or 10% of the days rented, whichever is larger.

The same logic applies if the dwelling unit is your replacement property — own the replacement 2 years after an exchange, rent it to someone other than direct family at fair value at least 14 days in each of the 2 years, and limit personal use to 14 days or 10% of the days rented, whichever is larger.

Personal Use and Holding Period

We are always asked “How much personal use is too much?” and “How long do I have to hold?” Many taxpayers dream of eventually moving into their rental property and converting it to a principal residence. Section 121 of the tax code defining the tax treatment on our homes even provides for this eventuality (§121(d)(10)).

This IRS Revenue Procedure 2008-16 provides a Safe Harbor answer when you are completing an exchange.

Fact Sheet 2008-18

In March 2008 the IRS published Fact Sheet 2008-18, entitled “Like-Kind Exchanges Under IRC Code Section 1031.” In the fact sheet the IRS explains exchange property qualifications, time limits, identification rules, importance of a Qualified Intermediary, computation of basis, and reporting the exchange. For more detailed instructions purchase the book How To Do A Like-Kind Exchange of Real Estate: Using a Qualified Intermediary by Ed Horan.

Bill Horan, a Certified Exchange Specialist®, and Ed Horan is Senior Exchange Consultant for Realty Exchange Corporation, Gainesville, VA.

This publication is designed to provide accurate information on tax-deferred exchanges. The publisher is not engaged in rendering legal or accounting services. If legal or tax advice is required, the services of a competent professional should be sought.

199A Comments to Treasury

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Ed Horan submits 199A comments to Treasury

Ed Horan submits 199A comments to Treasury
Ed Horan

Throughout last year’s tax reform process, Realty Exchange was heavily involved as part of an industry team to help save 1031 exchanges for real property. The team spent countless hours walking the halls of the Capitol, making great effort to ensure Congressional members knew the importance of 1031 exchanges in real property transactions.

Even after tax reform, Ed Horan continues to track 1031 exchange issues and provide input to regulators. He recently submitted comments to Treasury on the proposed 199A regulations which impact exchangers:

https://www.regulations.gov/document?D=IRS-2018-0021-0003

Ed’s comments were also picked up by Tax Notes, a collection of publications which provides news, analysis, and commentary for tax professionals.

Proud of Dad!

Related Parties

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Internal Revenue Code (IRC) Section 1031(f) establishes the special rules for exchanges between related parties. In addition, the IRS published “Revenue Ruling 2002-83” in November 2002, to clarify the purchase by an exchanger of the replacement property from a related party.

IRC Section 1031(f)(1)(C) requires that the property received in a related party exchange, by the exchanger or related party, be held for two years after the date of the last transfer which was part of the exchange.
If the exchange properties are held for two years, it is clear that:

First, an exchanger can do a direct exchange. A direct exchange occurs when the parties swap properties directly with each other. This normally occurs simultaneously and may involve a qualified intermediary.

Second, also allowed is the sale and transfer of the relinquished property to a related property. This normally is a deferred exchange using a qualified intermediary, with the exchanger buying the replacement property from an unrelated party.
However, regardless of the time the exchanger holds the new replacement property, or the use of a qualified intermediary, it is clear in the “Revenue Ruling” that purchase of the replacement property from a related party may result in the IRS disallowing the exchange.

Between family members, a related person is an individual and his or her spouse, siblings, parents and children. Not related are aunts, uncles, in-laws, cousins, nephews, nieces and ex-spouses. Certain business entities can also be related parties; for example, a corporation or partnership/LLC in which the exchanger has more than a 50% ownership interest is considered a related party.

For purposes of Section 1031(f), the term “related person” means any person bearing a relationship to the exchanger as described in Sections 267(b) or 707(b) (1). If there is any doubt as to the related party status of the seller of the replacement property, the exchanger should consult with his tax advisor.

If the exchange involves a related person, then Part II of IRS Form 8824, Like-Kind Exchanges, must be filed for the year of the exchange plus two additional years.

Based on IRC 1031(f) and Revenue Ruling 2002-83, it is clear that the purchase of a replacement property from a related party should be avoided.

Exception: If the related party seller of the replacement property is not cashing out (that is, he is also doing an exchange), then the replacement property may be purchased from a related party. The requirement remains that the replacement property must be held for a period of two years.

This publication is designed to provide accurate information on tax-deferred exchanges. The publisher is not engaged in rendering legal or accounting services. If legal or tax advice is required, the services of a competent professional should be sought.

Do You Need to File an On-Time Tax Return Extension for your 1031 Exchange?

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IRS Extension
IRS Extension

If you closed on your 1031 exchange relinquished property in the last quarter of 2017 and still have an active 1031 exchange you may want to file an on-time tax return extension.

The IRS 1031 regulations say: “The exchange period begins on the date the taxpayer transfers the relinquished property and ends at midnight on the earlier of the 180th day thereafter or the due date (including extensions) for the taxpayer’s return”.

If you closed on a relinquished property after October 2017, and will not receive your replacement property until after the normal 2017 income tax filing due date (Tuesday April 17, 2018, for individuals this year), you must file an on-time extension for the filing of your 2017 federal tax return to get the full 180 days to complete the exchange.

Taxpayers use IRS Form 4868 to file for an automatic six-month extension. If you closed on your relinquished property anytime in 2017, you must report the completed exchange on IRS Form 8824, Like-Kind Exchange, as part of your 2017 federal tax return. You may not file your tax return for 2017 until the exchange is completed.

You can find help with completing the IRS From 8824 here:  8824 Workbook Guide

Receiving 1031 Escrow Funds in Following Year

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The IRS 1031 regulation (§1.1031(k)-1(j)) provides that if an exchanger receives 1031 escrow funds from the qualified intermediary at the end of the exchange, or if the exchanger had a bona fide intent to do an exchange but does not complete the exchange by receiving a replacement property, then the gain on cash received will be reported for the tax year in which the exchanger actually receives the cash from the qualified intermediary.

Example of receiving 1031 escrow funds in the following year:

The exchanger relinquishes a debt free property on December 15, 2017, for $400,000. After expenses, the qualified intermediary receives $380,000 in 1031 escrow funds and places it in a qualified escrow account. The exchanger identifies a single replacement property and goes to settlement on the purchase on March 30, 2018. However, the exchanger only uses $300,000 of the 1031 escrow funds in escrow to purchase the replacement property. Following settlement, the qualified intermediary returns to the exchanger $80,000 (cash boot). The exchange is still reported on the Form 8824 for 2017. The cash boot, 1031 escrow funds, received in 2018 will be included on Line 20, but not carried forward to Line 22. The cash received in 2018 may be reported as an installment sale on IRS Form 6252.

Even if the exchanger does not complete the exchange by obtaining a replacement property – but there was a bona fide intent to exchange – then the gain may still be reported on an installment basis for the tax year the cash was received from the qualified intermediary. See IRS Publication 537, Installment Sales, for more details. An exchanger will have the choice to pay the taxes on the boot on the 2017 tax return or on the 2018 tax return.