In a 1031 tax deferred exchange, what amount of personal use is acceptable? If a vacation rental property is held for investment, how many days can the titleholder use for their family? A 1031 exchange is a well-documented tax deferral strategy recognized by the Internal Revenue Code (IRC) Section 1.1031. The theory is when a taxpayer, either domestic or foreign, sells real or personal property held in a trade, business or for investment and reinvests the sales proceeds and debt retired, their economic position has not changed. The taxpayer has not received the realized gain in the form of cash or reduced debt; consequently it would be unfair for a capital gain and recaptured depreciation tax to be paid. The gain is deferred when the replacement property is sold. When sold (and another 1031 exchange is not initiated), the original deferred gain plus any additional gain realized since the purchase of the replacement property is subject to tax.
As a general rule, when a taxpayer sells real property and realizes a gain on the property, the taxpayer is required to pay capital gains taxes on the gain realized. Although the rate at which capital gains are taxed fluctuates, it is typically enough to warrant looking for legal mechanisms to avoid the obligation. One mechanism used by many taxpayers is a Section 1031 Exchange. Named after the IRS section from which it stems, a Section 1031 contemplates an “exchange” of property instead of an outright sale. When a transaction qualifies for a Section 1031 Exchange, capital gains taxes on the realized gain are deferred. Can the sale of a vacation property qualify for Section 1031 treatment? If certain conditions are met, the answer is “yes."