Lee and Lisa are a married couple who live and work in Arizona. In addition to their main home in Arizona, they also own a vacation condominium in Kauai that was purchased in 2009 for $200,000. They have used the condo for approximately 6 weeks each year and have never rented it to third parties. Since their acquisition of the condo, its value has appreciated to over $600,000.

Lee and Lisa are getting tired of the condo environment and are considering replacing it with a private vacation home that they have identified. Because the cost of the private home is higher than their condo, they intend to rent the home out for at least 2 months each year for the next several years to help cover the additional cost. They ask for your advice on the following ideas

1. If they sell the condo, would they be eligible for the gain exclusion from the sale of a personal residence?
2. If option 1) is not possible, could they exchange their condo for the beach house (along with the additional investment) and receive 1031 tax-deferred exchange treatment (thus avoiding the gain recognition)?
3. What are the issues presented with this?