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Vacation Homes Vacation Homes IRC Rev. Proc. 2008-16 IRC Rev. Proc. 2008-16 § 1031 § 1031 New Rules and Pitfalls” New Rules and Pitfalls” Hosted by: Hosted by: 2008 GSCPA Tax Forum 2008 GSCPA Tax Forum Presented by: Presented by: William B. Hood, CPA William B. Hood, CPA Asset Preservation, Inc. Asset Preservation, Inc.

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Presentation of New IRS Revenue Procedure 2008-16 re: 1031 Exchanges of "Vacation Homes"

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Vacation HomesVacation HomesIRC Rev. Proc. 2008-16IRC Rev. Proc. 2008-16

§ 1031§ 1031

““New Rules and Pitfalls”New Rules and Pitfalls”

Hosted by:Hosted by:

2008 GSCPA Tax Forum2008 GSCPA Tax Forum

Presented by:Presented by:

William B. Hood, CPAWilliam B. Hood, CPA

Asset Preservation, Inc.Asset Preservation, Inc.

How about a little get away How about a little get away place?place?

How about something a little How about something a little less ostentatious?less ostentatious?

Some BackgroundSome Background

�� In the past, vacation homes, In the past, vacation homes, as defined in as defined in § 280A,§ 280A, has been a gray area for § 1031 treatmenthas been a gray area for § 1031 treatment

�� Rev. Rul. 59-229Rev. Rul. 59-229 Gain or loss from an exchange of personal Gain or loss from an exchange of personal residences may not be deferred – residences are residences may not be deferred – residences are not property held for productive use in a trade or not property held for productive use in a trade or business or for investmentbusiness or for investment

�� Rev. Proc. 2005-14Rev. Proc. 2005-14 § 1031 does not apply to property held solely as a § 1031 does not apply to property held solely as a personal residencepersonal residence

A Little More BackgroundA Little More Background�� PLR 8103117PLR 8103117

““the house and lot you acquire in this trade will be held for the same the house and lot you acquire in this trade will be held for the same purposes as the properties exchanged: to provide for personal purposes as the properties exchanged: to provide for personal enjoyment and to make a sound real estate investment.” enjoyment and to make a sound real estate investment.”

Although a PLR only applies to the facts and circumstances in a specific Although a PLR only applies to the facts and circumstances in a specific situation, in this instance, some limited personal enjoyment of a property situation, in this instance, some limited personal enjoyment of a property did not prevent a taxpayer from benefiting from a §1031 exchange. did not prevent a taxpayer from benefiting from a §1031 exchange.

In this PLR, however, it is important to note that the personal use was In this PLR, however, it is important to note that the personal use was minimal on the relinquished property in the years before the owner minimal on the relinquished property in the years before the owner initiated a §1031 exchange. initiated a §1031 exchange.

�� T.C. Memo. 2007-134T.C. Memo. 2007-134

Properties were held for personal use and that “mere hope or Properties were held for personal use and that “mere hope or expectation that the property may be sold at a gain cannot establish expectation that the property may be sold at a gain cannot establish intent if the taxpayer uses the property as a residence”intent if the taxpayer uses the property as a residence”

Barry E. Moore v. Barry E. Moore v. CommissionerCommissioner

The taxpayers never rented or attempted The taxpayers never rented or attempted to rent the property.to rent the property.

The taxpayers deducted mortgage interest The taxpayers deducted mortgage interest as a “home mortgage interest” expense as a “home mortgage interest” expense rather than investment interest expense.rather than investment interest expense.

The taxpayers did not take (and possibly The taxpayers did not take (and possibly did not qualify for) depreciation or other did not qualify for) depreciation or other tax benefits associated with investment tax benefits associated with investment property, including deductions or property, including deductions or maintenance expenses.maintenance expenses.

Rivera v. CommissionerRivera v. Commissioner In the tax court case, Rivera v. Commissioner In the tax court case, Rivera v. Commissioner

(2004), the tax court noted that, "...the term (2004), the tax court noted that, "...the term ‘income' is not confined to recurring income but ‘income' is not confined to recurring income but may also apply to gains from the disposition of may also apply to gains from the disposition of property." In this case, the court found the property." In this case, the court found the taxpayers held the property for investment taxpayers held the property for investment purposes because they had purchased it with the purposes because they had purchased it with the expectation it would increase in value. The court expectation it would increase in value. The court referenced Section 1.183-2(b) of the Income Tax referenced Section 1.183-2(b) of the Income Tax Regulations which outlines nine factors indicating Regulations which outlines nine factors indicating whether or not a taxpayer is involved in a venture whether or not a taxpayer is involved in a venture that is intended to produce a profit.that is intended to produce a profit.

IssuesIssues

�� IRS recognizes that some taxpayers hold dwellings for the IRS recognizes that some taxpayers hold dwellings for the production of income and also use the properties on an production of income and also use the properties on an occasional basis for personal use. Rev. Proc. 2008-16 occasional basis for personal use. Rev. Proc. 2008-16 provides safe harbor under provides safe harbor under § 1031§ 1031even if the taxpayer uses even if the taxpayer uses the dwelling for personal use (effective date for exchanges the dwelling for personal use (effective date for exchanges of dwelling units on or after March 10, 2008).of dwelling units on or after March 10, 2008).

�� This Rev. Proc. Applies to a dwelling unit as:This Rev. Proc. Applies to a dwelling unit as:Real Property improved with a house, apartment, Real Property improved with a house, apartment, condominium, or similar improvement that provides basic condominium, or similar improvement that provides basic living accommodations including sleeping space, living accommodations including sleeping space, bathroom and cooking facilities.bathroom and cooking facilities.

Safe HarborSafe Harbor

Sets specific rulesSets specific rules No method for interpretation of No method for interpretation of

variationsvariations No mention of “non-safe harbor” No mention of “non-safe harbor”

exchangesexchanges Gives explicit approval for “limited Gives explicit approval for “limited

personal use”personal use”

Requirements

The relinquished and replacement properties are owned by the taxpayer for at least 24 months (the qualifying use period);

Within each of these two 12 month periods constituting the qualifying use period the taxpayer must:

Rent the property to another person or persons at fair Rent the property to another person or persons at fair market rent for 14 or more days (family members (market rent for 14 or more days (family members (§ 267 (c) § 267 (c) (4) ) (4) ) qualify if they use the property as the primary qualify if they use the property as the primary residence); andresidence); and

The taxpayer’s personal use of the dwelling unit cannot The taxpayer’s personal use of the dwelling unit cannot exceed the greater of 14 days or 10 percent of the time it is exceed the greater of 14 days or 10 percent of the time it is rented.rented.

Conversions to/from Personal Conversions to/from Personal ResidencesResidences

Conversion of vacation rental property is still viable, however, the Conversion of vacation rental property is still viable, however, the safe harbor requirement implies waiting 24 months to convertsafe harbor requirement implies waiting 24 months to convert

Sale of a principal residence acquired via a Sale of a principal residence acquired via a § 1031 requires a 5 § 1031 requires a 5 year holding periodyear holding period

Except new § 121 exclusion allocation rules are included in the Except new § 121 exclusion allocation rules are included in the Housing Assistance Tax Act signed into law on July 30, 2008Housing Assistance Tax Act signed into law on July 30, 2008

The eligible exclusion of the gain on a principal residence The eligible exclusion of the gain on a principal residence (for sales after 01/01/2009) is allocated by a fraction with (for sales after 01/01/2009) is allocated by a fraction with the number of qualifying years as the numerator and the the number of qualifying years as the numerator and the total number of years owned as the denominator. total number of years owned as the denominator. Example: taxpayer lived in the residence 2 out of 5 years. Example: taxpayer lived in the residence 2 out of 5 years. 2/5 of the gain is eligible for the exclusion.2/5 of the gain is eligible for the exclusion.

Areas of DiscussionAreas of Discussion

Duplex? – Split Treatment – Dwelling unit Duplex? – Split Treatment – Dwelling unit and “Held for Investment” Unit?and “Held for Investment” Unit?

Real property – Unimproved but with Real property – Unimproved but with dwelling features e.g. tree house in a dwelling features e.g. tree house in a hunting preserve?hunting preserve?

Less than 24 months ownership?Less than 24 months ownership? Others? e.g. Others? e.g. § 6694§ 6694

Areas of Abuse/PitfallsAreas of Abuse/Pitfalls

Misrepresentation on the bank Misrepresentation on the bank mortgage applicationmortgage application

Use vacation home of more than 14 Use vacation home of more than 14 days or 10% of days rented by days or 10% of days rented by taxpayer or related partiestaxpayer or related parties

Maintenance days Maintenance days – No proof of workNo proof of work– Taxpayer visit or family participation?Taxpayer visit or family participation?

Planning Strategies

�� Substantiate investment intent (the Substantiate investment intent (the IRS likes facts and IRS likes facts and circumstances):circumstances):

�� Report rental income, attempts to Report rental income, attempts to rent property or conversion from a rent property or conversion from a

second home to a rental property second home to a rental property held for investment (document intent)held for investment (document intent)

�� Treat property as held for Treat property as held for investment on investment on the tax returnthe tax return

In the Event of an AuditIn the Event of an Audit

How does the IRS know about How does the IRS know about abusive personal use?abusive personal use?– Slip of the tongue by the taxpayerSlip of the tongue by the taxpayer– Cell phone usage tracked by cell towerCell phone usage tracked by cell tower– Pro Shop recordsPro Shop records– Credit card receipts for gasoline, area Credit card receipts for gasoline, area

restaurantsrestaurants– IRS tip lineIRS tip line

Questions?Questions?

William B. Hood, CPAWilliam B. Hood, CPA

Division ManagerDivision Manager

Asset Preservation, Inc.Asset Preservation, Inc.

770-641-1031 Office770-641-1031 Office

866-370-1031 Toll free866-370-1031 Toll free

770-597-8184 Cell770-597-8184 Cell

678-348-7162 Fax678-348-7162 Fax

[email protected]@apiexchange.com

www.apiexchange.comwww.apiexchange.com