Let’s address the question of whether you can do a 1031 exchange on your second or vacation home in Houston or Galveston, Texas or frankly in any one of these United States.
While a primary residence cannot be used in a 1031 exchange as per the Internal Revenue Code, vacation homes and second homes may qualify under certain conditions. The IRS gave clarity on this matter in 2008 under Revenue Procedure 2008-16. With that being said, there are specific guidelines that must be met in order for your vacation or second home to be eligible for a 1031 exchange.
The first guideline requires that the vacation or second home have been held by you for at least 2 years prior to the exchange. This holding period shows the IRS that the property was primarily used for investment purposes, even if it was also used occasionally for personal vacation time. Within this two-year period, the property must be rented out to an unrelated tenant at fair market value for at least two weeks each year. This rental requirement ensures that the property is actively used as an investment rather than purely for you to enjoy the beautiful view of Galveston, Texas.
Additionally, your personal use cannot exceed 2 weeks per year or 10% of the total days the property was rented out, whichever is greater. For example, If the property was rented out for 100 days in one year, your personal use should not exceed 10 days.
Finally, the same rules that apply to the relinquished property also apply to the replacement property acquired through the 1031 exchange. This means that the replacement vacation or second home must also be rented out at fair market value for at least two weeks per year, and personal use must remain within the above-described limits.
Lastly, it is a priority to consult with a CPA or tax attorney prior to ensure a full compliance with these rules.