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Q: I have been an avid reader of Robert Bruss' real estate Q and A in
the Los Angeles Times for many years and one item caught my eye a
couple of weeks ago regarding vacation homes and how they don't
qualify for 1031 exchanges. And yet you are always talking about how
many of these types of exchanges are used in and out of Mammoth.
What's up?
A: That question appeared in late July and read Q: About a
year ago my husband and I bought a vacation condo at a ski resort.
When we are not using it, the management company rental pool is
suppose to keep our condo rented. However, that company takes 40% of
the rental income. We also have to pay a homeowner's association fee.
So far, our condo is not paying for itself as we had hoped. If we
sell it, would we have to reinvest in another rental property to
avoid paying tax on our sale profit?
Robert Bruss' answer was: It doesn't matter what you do with
the profit; it's still taxable. Since the vacation condo is not your
principal residence, nor is it a rental property, your capital gain
will be taxed at the new 15% maximum federal tax rate, plus any state
tax due. Because you partly used the condo for personal use, its sale
is not eligible for an Internal Revenue Code 1031 tax-deferred
exchange. For full details, please consult your tax advisor.
So I did consult the man who is definitely the expert in this
area. Timothy S. Harris is an attorney at law and President of TIMCOR
Financial Corporation in Los Angeles. TIMCOR is the "accommodator" or
"strawman" in many of the exchanges we see in and out of Mammoth.
They basically facilitate the 1031 exchanges. They have doing this
since 1977 and have successfully completed thousands of exchanges.
Mr. Harris emphasized that vacation homes may qualify if
personal use is limited, or if the home is also rented. But primarily
the home must be held for "investment purposes". Here's where it gets
a little technical. Mr. Harris sent me some printed material from a
legal textbook on the subject. Here's what it says.
"A property is apparently not "held for investment" within
the meaning of the IRC Section 1031 if losses from a sale or exchange
of the property cannot be deducted... Section 280A governs the
deductibility of losses from a vacation or second home, and therefore
apparently whether the home is held for investment for the purposes
of Section 1031. Section 280A provides that a taxpayer may not deduct
losses with respect to a dwelling unit used a residence by the
taxpayer during the taxable year."
" Section 280A provides that a taxpayer uses a dwelling unit
as a residence if the taxpayer uses the unit for personal purposes
for a number of days exceeding the greater of 14 days, or 10% of the
number of days during the year for which such dwelling unit is rented
for fair market value."
"For these purposes, personal use includes the use of the
unit by persons related to the taxpayer, unless the persons use the
unit as a principal residence and they are paying fair rental. This
definition also applies to determine if a taxpayer may deduct the
mortgage interest related to a property as a "second home."
Ultimately the textbook is quoted "Whether or not the rigid
test of IRC Section 280A applies, a taxpayer who uses a vacation home
more than incidentally during the taxable year of the exchange is
probably not holding it for investment for the purposes of IRC
Section 1031. Therefore, a taxpayer desiring to exchange an interest
in a vacation home under IRC Section 1031 should, at minimum, not
exceed the personal use limits of IRC Section 280A(d) and should rent
the property at fair rental at least during the year in which the
exchange occurs and preferably longer."
Also of interest to many Mammoth homeowners who fall into
this category; "The IRS has also ruled that the use of the property
ten days per year for maintenance purposes will not disallow an
exchange." Does that maintenance include the tuning of skis?
Mr. Bruss' response brings up another interesting topic
regarding capital gains taxes. The recent tax law changes actually
drop the capital gains tax to only 5% (federal) for those in the 10
and 15% tax brackets and zero in the year 2008. And in Mammoth there
is a whole group of longstanding property owners who are retired (and
can very well fit in those tax brackets) and are wondering what to do
with their highly inflated Mammoth real estate. The answer is clear
until they hedge those tax rates (after the election) may go lower
and prices in Mammoth may go higher.
In the meantime, if a tax deferred exchange is in your
future, make sure you prep your advisors about your intentions so
there are no ugly surprises, because this truly is an excellent tool
for property owners making moves into and out of the Mammoth real
estate market.
Paul Oster is Broker/Owner of RE/MAX of MAMMOTH. An archive of past
Q&A columns can be found at
www.remax-mammoth.com. You can send him your real estate related
questions to Box 2618, M.L. CA 93546-2618 or email him at
pauloster@qnet.com. All questions will be researched and presented
with the greatest care but the accuracy is not guaranteed. For legal,
accounting,construction, etc., advice-seek out the appropriate
professional
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