Can I 1031-Exchange My Tiny House?

Wikipedia defines a small house as one ranging from 400 to 1,000 square feet.  A tiny house is one that is less than 400 square feet.  Do people really live in spaces that small? Actually, yes – and they’re more common and popular than you might imagine.  I don’t know if they’ve always been out there and I just never noticed (probably), or if it’s a completely new trend that just popped up and made popular by the numerous TV programs that have sprung up recently.

Different kinds of real estate range in popularity depending on the region: small condos and co-ops are common in major markets like New York.  Houses that have been retrofitted into several small flats are common in markets like San Francisco.  Park model homes are small, pre-manufactured houses that can be found throughout the United States, but particularly in the South.  Townhomes are everywhere and many meet the definition of small.  We are now seeing developed communities where individual small townhomes or park models are arranged around a common core with community services.  The community services in the core areas differ depending upon the characteristics of the small home owners – coffee shops, small restaurants and dry cleaners for young professionals.  Or a theater, library, game rooms, hobby rooms (like pottery, woodworking and jewelry making) in a retirement community.  These types of communities are starting to become popular in vacation areas – short term rentals of the home with use of the common area facilities.

So: what does all this have to do with 1031 exchanges?

Section 1031 of the Internal Revenue Code lets you roll the gain from the sale of your old investment real estate over into the purchase of a new investment real estate.  Could you do a 1031 exchange on a tiny house?  Yes – the size of the property has nothing to do with your ability to do a 1031 exchange. What’s most critical here is whether or not you held the property for investment.  If you sell a condo that you’ve rented out for at least a year, then yes: you can do a 1031 exchange and buy a different rental property of any size.

Section 1031 requires that if you sell real estate, you must buy real estate to defer the gain from the sale.  One thing you do have to be careful of regarding many small houses is their portability, and whether a manufactured home meets the definition of “small house” in a given county.  Many of the TV shows feature tiny houses constructed or reconstructed on flat bed vehicles.  In other words: the house has wheels and is moveable.  Moveable properties are not considered real estate, so they cannot be exchanged for permanent property, but they can be exchanged for another moveable property.

Houses that are potentially moveable are a strange subset of the law.  To qualify for a 1031 exchange, both the old and the new property must be considered real estate for property tax purposes, or both must be considered moveable for property tax purposes.  One county might consider a house on wheels with a skirt around the bottom to be “real estate,” while another county might consider a manufactured home, set on a concrete foundation with the wheels permanently removed, “moveable.” So, if you’re buying and/or selling a property of this type, make sure that the property tax authorities of both counties treat them the same. As an aside: converting a property from “moveable” to “permanent” on a typical county’s tax rolls usually involves completing a form and paying a small processing fee of about $25 to $100.

Just remember: what you exchange into must be like-kind (IRS-speak for: “the same as”) to what you sold.  It doesn’t mean that your new property must also be a small house, but if the old property was considered moveable by the county, the new one will have to be considered moveable as well. 

And lastly: don’t forget that to do a 1031 exchange, both properties must be used in a business or rented; which means that, no – you cannot exchange the tiny man-cave you built in the back yard for a rental condo downtown.