Vacation home exchange oversight recommended

A recent report from the Treasury Inspector General for Tax Administration says like-kind Exchanges require greater oversight to ensure taxpayer compliance. One area of particular importance to taxpayers is increased oversight of vacation or second home exchanges.

It is fairly clear that a vacation home used exclusively by the owner or related parties may not be exchanged. When the home is not used exclusively by such persons, or where this is some rental history or attempts to rent, there is no published position by the IRS.

According to the report, this leaves “unrebutted, the sales pitch of like-kind exchange promoters” who may encourage taxpayers to exchange non-qualifying vacation homes. Many of these promoters also advise the taxpayer on exchanging primary residences with gain over the IRC § 121 gain exclusion. It also notes that realtors “who may not be well versed in tax law” may advise amateur real property “flippers”, who are really dealers, that these flips qualify for § 1031. Likewise, taxpayers also claim an exchange despite that they’ve taken possession of the cash proceeds from the sale. Unscrupulous or uninformed promoters are taking advantage of the IRS’s silence on the vacation home issue.

The IRS agrees to act on the Report’s three recommendations. They have agreed to provide additional guidance regarding exchanges of second and vacation homes that were not used exclusively by the owners. It will also caution taxpayers to be wary of individuals promoting improper use of like-kind exchanges.

The Report concludes that the IRS is relying on taxpayers to voluntarily comply, and this has resulted in underreporting of gain. Hence, it states, section 1031 is a “promising target” for additional research to improve reporting compliance.