Can you buy a vacation home in a 1031 exchange? The short answer is yes. 

It’s possible under certain circumstances to sell your investment real estate and buy a vacation home with a tax-deferred Internal Revenue Code Section 1031 exchange.  

This means you can sell your dwelling unit — defined as “real property improved with a house, apartment, condominium, or similar improvement that provides basic living accommodations including sleeping space, bathroom and cooking facilities” — and exchange it for a vacation home without the tax burden that would have resulted from a straight sale. 

To determine if your investment real estate (relinquished property) and vacation home (replacement property) will qualify for a Section 1031 exchange, check out the IRS guidance in Revenue Procedure 2008-16.

A dwelling unit a taxpayer intends to relinquish in a 1031 exchange qualifies as property held for productive use in a trade or business or for investment if:

• The dwelling unit is owned by the taxpayer for at least 24 months immediately before the exchange — the qualifying use period.
• Within the qualifying use period, in each of the two 12-month periods immediately preceding the exchange, the taxpayer rents the dwelling unit to another person or persons at a fair rental for 14 days or more, and the period of the taxpayer’s personal use of the dwelling unit doesn’t exceed the greater of 14 days or 10 percent of the number of days during the 12-month period the dwelling unit is rented at a fair rental.

A dwelling unit a taxpayer intends to be the replacement property in a 1031 exchange qualifies as property held for productive use in a trade or business or for investment if:

• The dwelling unit is owned by the taxpayer for at least 24 months immediately after the exchange — the qualifying use period.
• Within the qualifying use period, in each of the two 12-month periods immediately after the exchange, the taxpayer rents the dwelling unit to another person or persons at a fair rental for 14 days or more, and the period of the taxpayer’s personal use of the dwelling unit doesn’t exceed the greater of 14 days or 10 percent of the number of days during the 12-month period the dwelling unit is rented at a fair rental.

Consult with your tax and legal advisors to determine if this Section 1031 exchange strategy will work for you.