Owning your own vacation home can be a paradise for those fortunate enough to invest in a second home or apartment. Not only does a second home provide a great source of income, but it can also be enjoyed any time of the year when guests are not around.
Of course, if the right opportunity comes, selling a vacation property can be an attractive idea for a quick lump sum of cash. When weighed against the ongoing maintenance, marketing, and upkeep of a leased second home, a large sale is a great way to diversify your wealth once the allure of frequent getaways has worn off.
Unfortunately, with a large sum of cash being transferred to personal income, vacation home sales often lead to excessive taxation from the IRS. High valued vacation rentals are subject to capital gains taxes, which can be deferred in a simple 1031 exchange.
Vacation homes are one of the most commonly used assets in 1031 exchanges, as many wealthy investors have seen the opportunity to “trade up” for new property tax-free. In this article, we will outline the steps necessary to 1031 exchange second home or other vacation property and avoid capital gains tax and maximize profit.
How to Sell A Second Home
Before you can 1031 exchange vacation home, you will first need to sell it. If you’ve owned your second home for a while, chances are that you’ve had your fair share of offers from guests after their week in paradise. Whether or not you should take these handshake deals is up to you, know that the 1031 exchange is a much better way of selling your vacation property in the 21st century.
Determining the Value of A Vacation Home
With rapid acceleration in condensed areas, a second home can bring a tremendous gain in the right areas of the country. Conversely, natural disasters, poor upkeep, or depleting local economies unfortunately often land vacation property sellers with less than what they paid for originally.
If you plan to list your vacation home yourself or would like to get a ballpark idea of its value before speaking with a broker, one must consider the following factors to determine the value of a vacation home:
- Size of home
- Condition and upkeep
- Current leasing price and rental history
- Community amenities
- Staffed or contracted services onsite
In popular vacation destinations, there are many similar vacation rentals within close proximity to one another. If you are selling in a dense area, the easiest way to get an idea of your second home’s value is to look at local listings for buildings and land that share similar characteristics with your vacation home.
Taxes Paid on the Selling Second Home
Unlike in the sale of a personal residence, vacation homes that can be considered a business or second home are subject to capital gains taxes in the event of a sale. Capital gains taxes can be as high as 20% on expense vacation homes, in addition to the federal, local, and sales taxes that are also applied to the bill of the sale. With every dollar adding up, many investors choose to defer capital gains taxes on sales through a 1031 second home exchange.
How to 1031 Exchange Vacation Home
In a 1031 exchange, vacation home sellers must purchase a new asset “in exchange” for their old property. If the new property is of equal or greater value, then taxpayers through the 1031 exchange have the opportunity to defer every dollar of capital gains taxes. In the same vein, lower-valued assets can be purchased for a partial omittance of capital gains taxes.
Vacation Home Like-Kind Properties
As alluded to above, vacation homes are some of the most commonly used assets in 1031 exchanges. Sales of second homes are subject to taxation, but capital gains taxes are completely avoided with the proper paperwork and the purchase of a new “like-kind” asset. In a 1031 exchange vacation home can be exchanged for many like-kind assets, including:
- Apartment Buildings
- Trailer Parks
- Convenience Stores
- Golf Courses
- Water and Ditch Rights
- Mineral Rights and Royalties
- And more
Timeline For a 1031 Second Home Exchange
Once your second home is sold, you have exactly 180 days (or about six months) to purchase a new property for a valid 1031 exchange of the second home. If filed correctly, taxpayers will completely defer capital gains taxes in the year of which the exchange was completed. Additionally, it is important to note that one “reasonable” property must be identified within 45 days of a vacation home sale for the taxpayer to remain eligible for the 1031 exchange.
For additional requirements, please see our 1031 Exchange Rules and Requirements Page.
Using an Intermediary to 1031 Exchange Second Home
For most, the process of filing governmental paperwork and meeting strict deadlines can be daunting in an already busy life. Because of this, many sellers will choose to work with an intermediary in order to 1031 exchange vacation home smoothly and make sure the reinvestment is maximized when identifying the new asset for the 1031 exchange.
What’s the Best 1031 Exchange For a Vacation Home?
Although taxpayers are free to 1031 exchange second homes for a wide variety of new properties, mineral rights offer a unique opportunity for investors looking to maximize their wealth. In the United States, mineral rights can be leased to oil and gas companies to explore, extract, and sell natural resources from the subsurface of a property. In doing so, mineral rights owners earn oil and gas royalties as a fixed percentage from the monthly operations.
After years and years of vacations, when it comes time to sell your vacation home, 1031 exchange is one of the best decisions that can be made. If you are seeking an income stream that is a bit more passive than maintaining a second home, mineral rights are one of the best new properties that can be purchased income tax-free in a 1031 exchange.