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Primary Purpose for Owning a Vacation Home is Key
In a decision rendered on May 30, 2007, the U.S. Tax Court held that if a taxpayer uses a vacation home exclusively for personal use, but also holds if for appreciation potential; the vacation home fails to qualify as property held for investment for purposes of IRC s. 1031.
The taxpayers and their children in the case used the vacation home exclusively for recreational purposes, and never rented or offered to rent the vacation home to third parties. One of the taxpayer's motives in acquiring the vacation home, however, was the prospect of appreciation resulting in profit on the eventual sale of the property.
The issue in front of the Tax Court was whether the home was held "for investment" which in turn, according to the Court, depended on the intent or purpose in holding the property, as determined at the time of the exchange. Acknowledging that the taxpayers did hold the home for appreciation, and hypothesizing that one of the reasons most taxpayers hold their personal residences and second homes is for appreciation, the Court determined that it "is a taxpayer's primary purpose in holding the propert[y] that counts."
In trying to determine the taxpayer's purpose in holding the property, the Court found several objective facts important:
- Taxpayer's never made the property available for rent;
- Taxpayer's added a deck and screened-in porch, installed a satellite television receiver, and purchased a television, a VHS recorder, and a new washer and dryer for their use at the property;
- They replaced furniture and kept a boat on the lake, which they used for boating and fishing;
- The house was "of some substance"
- Taxpayer's failed to claim any tax deduction for maintenance expense or depreciation connected with the property;
- Taxpayer's treated all interest deductions relating to the property as home mortgage interest rather than investment interest.
In short, according to the Tax Court, the evidence demonstrated that the taxpayer's primary purpose in acquiring and holding the property was to enjoy the use of the property as a vacation home.
This case confirms that holding a home for appreciation is not sufficient to establish an investment intent for purposes of 1031 exchanges, especially if the home is utilized by the taxpayer as a vacation home. Second homes, however, can and do qualify as investment property when the objective factors indicate such use. A second home owner contemplating the exchange of an appreciated property should contact their tax advisor in advance of the sale to determine whether the property will currently qualify, or whether it could qualify in the future with proper planning.
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