If you own a short-term rental property in Montana, you might be aware of recent discussions regarding the prohibition of certain types of short term rentals (STRs) in residential neighborhoods of Bozeman. Similar regulations are being considered in Missoula too.

The issue will involve an interpretation of the zoning code, likely leading to legal challenges and debates before a firm resolution is reached. The uncertainty may prompt STR owners to consider selling their properties.

For those contemplating a sale, determining eligibility for a 1031 Exchange is a crucial initial step. The IRS has specific criteria to distinguish between a personal vacation home and an income-producing investment property.

Can I 1031 Exchange my STR?

The IRS views STRs as residing in a gray area between personal vacation homes and income-producing properties. While you cannot 1031 exchange a personal vacation home, you can exchange an income-producing property. To help make this determination, the IRS has established certain standards.

1031 Eligibility Test 1 | How Long Have Your Owned Your STR?

The taxpayer must own the dwelling unit for at least 24 months immediately before the exchange (the “qualifying use period”). If you purchased the property in 2020, you should meet this requirement. If you bought it at the end of 2022, you’ll need to wait.

1031 Eligibility Test 2 | Have You  Rented Your STR Out?

Within the qualifying use period, in each of the two 12-month periods immediately preceding the exchange:

The taxpayer must rent the dwelling unit to another person for a fair rental for 14 days or more. If you had paying guests for at least 14 days in each of the past two years, you pass this test.

1031 Eligibility Test 3 | How Much Personal Time Have Your Spent At Your STR?

The period of the taxpayer’s personal use of the dwelling unit should not exceed the greater of 14 days or 10 percent of the number of days the unit is rented at a fair rental during the 12-month period.

If you used the STR for personal purposes for more than the allowed period, you might be ineligible.

Did You Pass The Test?

If you pass all three tests, you can likely proceed with a 1031 Exchange.

If you don’t pass the tests and still wish to exchange the property in the future, strategic management and monitoring the ratio of personal use to income-generating days become crucial.

In the case that you can no longer operate your property as an STR, converting it to a long-term rental could still make you eligible for a 1031 Exchange.

Always confirm issues dealing with taxes with your attorney and accountant, and be prepared to provide documentation.