The Tax Court
recently ruled that the sale of a vacation home and the purchase
of another through an escrow agent did not qualify for tax-free
like-kind exchange treatment under Sec. 1031 because the homes
were not held for investment (Moore, TC Memo 2007-134).
The taxpayers (P) used the homes
exclusively for recreational purposes and never rented or
attempted to rent out the homes to others. P’s argument
that he purchased the property with the expectation that the
property’s value would increase and he would sell the property at
a profit was not enough to qualify it as property held for
investment.
P purchased a second home three
hours away from his principal residence. From April to September,
P’s family would use the property exclusively for
recreational purposes two or three times a month until Labor Day
(when the property would be closed until the following spring).
During the off months, P would occasionally visit the
property to rake leaves and perform other caretaker functions
consistent with using the property as a vacation home.
P eventually moved his principal residence farther
away from the vacation home. He began using the property less
frequently and it became run down. P decided to purchase
another vacation home closer to his new principal residence and
treated the purchase and sale of the vacation homes as a tax-free
like-kind exchange under Sec. 1031.
To qualify for
like-kind exchange treatment under Sec. 1031:
- Both properties exchanged must be of like kind;
- Both properties must be held for trade, business, or investment purposes; and
- The exchange must satisfy the procedures of a like-kind exchange under Sec. 1031(a)(3).
According to the court, the properties sold and
purchased did not satisfy the trade/business/investment
requirement. Neither the Code nor the regulations defines “held
for investment” for purposes of Sec. 1031. The courts have ruled
that the primary purpose in holding the properties must be for
trade, business, or investment purposes to qualify under Sec. 1031
(Montgomery, TC Memo 1997-279) and that the investment
test is applied at the time of exchange without regard to the
taxpayer’s motive before the exchange (see Bolker, 81 TC
782 (1983), aff’d 760 F2d 1039 (9th Cir. 1985)).
The Tax Court did not dispute P’s argument that he
purchased the property with the expectation that its value would
appreciate. However, it held that P’s primary use of the
property was as a vacation home. At no point did P ever
try to rent the property to third parties or have the property
available for sale until he was ready to purchase a second
vacation home. The mere hope or expectation that property may be
sold at a gain cannot establish an investment intent if the
taxpayer uses the property as a residence (Jasionowski,
66 TC 312, 313 (1976)).
In addition,
P stopped maintaining the first property when he no
longer used it for personal purposes. The Tax Court found that
this was inconsistent with an intent to maximize profit on the
sale of property and demonstrated that continued maintenance was
warranted only in connection with personal use. Furthermore, on
P’s tax return, he listed deductions for “home mortgage
interest,” not investment interest, nor did he deduct any
depreciation, maintenance, or other expenses associated with the
property. According to the Tax Court, this reporting is not
consistent with holding the property for trade, business, or
investment purposes.
EditorsNotes
Joel E. Ackerman, CPA, MST is with Holtz Rubenstein Reminick LLP, DFK International/USA Melville, NY.
Unless otherwise noted, contributors are members of or associated with DFK International/USA.
If you would like additional information about these items, contact Mr. Ackerman at (631) 752-7400 x262 or jackerman@hrrllp.com.