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The following story is from the February 19 issue of the Daily Tax Report.

Like-Kind Exchanges

New Safe Harbor for Like-Kind Exchanges
Of Rentals Allows Occasional Personal Use

The Internal Revenue Service Feb. 15 unveiled Revenue Procedure 2008-16, offering a safe harbor under which it will not challenge whether a dwelling unit qualifies as property held for productive use in a trade or business or for investment for purposes of like-kind exchange treatment under tax code Section 1031.

In general, IRS said it would allow the tax-free exchanges for property that is rented to others but also occasionally used by the owners for personal purposes. Taxpayers must own the housing unit for at least two years before the exchange.

In each of the two years prior to the trade, the taxpayer must rent the property at a fair price for 14 days or more, IRS said. The guidance stipulated that the taxpayer's own use of the housing unit cannot exceed 14 days or 10 percent of the days the unit is rented at a fair price.

Facts-and-Circumstances Test

The agency said it would determine personal use by referring to tax code Section 280A(d)(2), and would determine fair rental based on all of the facts and circumstances that exist when the rental agreement is entered into. "All rights and obligations of the parties to the rental agreement are taken into account," IRS said.

The revenue procedure also provided a special rule for replacement property. The rule applies in cases where a taxpayer files a federal income tax return and reports a transaction as an exchange under tax code Section 1031, based on the expectation that a housing unit will meet the qualifying use standards for replacement property, and subsequently determines the standards will not be met.

In such cases, IRS said, the taxpayer should file an amended return and not report the transaction as an exchange under Section 1031.

Safe Harbor Limited, IRS Says

The agency noted the safe harbor should be used only to determine whether a housing unit qualifies as property held for productive use in a trade or business or for investment under Section 1031. Taxpayers also must satisfy all other requirements for a like-kind exchange under Section 1031 and the accompanying regulations, IRS said.

The guidance is effective for exchanges on or after March 10, 2008, but no inference is intended on the federal tax treatment of exchanges before that date, IRS said.

Rev. Proc. 2008-16 is scheduled for publication March 10 in Internal Revenue Bulletin 2008-10.

Text of Rev. Proc. 2008-16 is in TaxCore.

By Alison Bennett

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