Section 1031 of the tax code allows you to exchange one investment property for another without paying tax on the appreciation. Generally, you sell your property, have an unrelated intermediary hold the proceeds, and then direct the money to be used to buy another property.
Such a transaction might appeal to owners of vacation homes. Suppose Bob and Diane Jones have owned a beach house in Delaware for many years. Purchased for $50,000, it can be sold for $500,000.
Bob and Diane, who are planning to retire in Arizona, want to swap their beach house for another vacation home in a Colorado ski area. Assuming they have rented their beach house sufficiently, it may qualify as rental property and thus be eligible for a tax-free exchange.
If their personal use has been less than 14 days a year, they may have grounds for treating their house as investment property. The same is true if they have used the house more than 14 days but still less than 10 percent of the days it has been rented to others. Some observers say that merely buying a second home in the hope of appreciation is enough to qualify it as investment property, eligible for a tax-free exchange, but that view is far from certain.
