Can a Vacation Home be Exchanged in a Like Kind Exchange?

If a transaction is properly structured, the sale and purchase of vacation homes may qualify for like kind exchange treatment. In one recent Tax Court case, however, the taxpayers did not properly structure their vacation property exchange and were denied like kind exchange treatment.

In the case of Moore v. Commission, T.C. Memo. 2007-134 (5/30/07), the Tax Court, in a memorandum decision, held that the taxpayers who exchanged their vacation home for another vacation home were not entitled to treat the transaction as a like-kind exchange because the properties were not held primarily for investment. One of the essential requirements in a like kind exchange transaction is that the properties must be held in a trade or business or for investment (as opposed to personal use property).

The taxpayers, in the Moore case, essentially sold one vacation home and purchased a replacement vacation property. On their income tax returns, the taxpayers claimed deductions for home mortgage and investment interest and they did not list on their returns any deductions for maintenance or other expenses associated with the properties. Also, the taxpayers never rented or attempted to rent the property, and they never offered either property for sale until forced to do so by liquidity problems.

When challenged by the IRS, the taxpayers argued that one of the reasons they acquired both properties was for their appreciation potential and that this indicated their investment intent in holding the properties, thus qualifying them for like-kind exchange treatment.

The Tax Court held that neither the vacation home that was sold nor the new replacement vacation home was held for investment and, therefore, the taxpayers were not entitled to treat the disposal of the first property and acquisition of the latter property as a like-kind exchange. In rejecting the taxpayer’s argument, the Court held that it is a taxpayer’s primary purpose in holding properties that is determinative. The Court accepted the fact that the taxpayers hoped that both properties would appreciate but noted that the mere hope that a property may be sold at a gain cannot establish an investment intent if the taxpayer uses the property as a residence. Overwhelming evidence demonstrated that the taxpayer’s primary purpose in acquiring and holding both the properties was to enjoy the use of those properties as vacation homes.

We are often asked to counsel individuals on structuring the sale and purchase of real estate involving a vacation home so that the transactions will qualify as a like kind exchange. If you are interested in exploring this with your property transactions, please contact Andy Hochberg.