There are specific requirements for identifying and acquiring potential replacement properties when doing a 1031 exchange. In a typical exchange, the identification timeline starts on the date you sold your relinquished property and ends on the 45th calendar day after the sale.
Once identified, the IRS requires that you send the details of the identified properties to your qualified intermediary. Remember that you can always change your list of identified property up to the 45th day deadline.
How do I Actually Identify?
To qualify for tax deferral in a 1031 exchange, the section 1031 of the IRS tax code requires you to do the following when identifying a replacement property:
- Send a written document signed by the Exchanger;
- Hand delivered, mailed, telecopied, or otherwise sent;
- Before the end of the identification period to your Qualified Intermediary
Furthermore, your identified replacement properties must be clearly described i.e. the type of property, street address, and any other distinguishing information. Although you may be able to identify more than one replacement property, you must adhere to the IRS-stipulated three rules of identification in a like-kind exchange.
- Three Property Identification Rule
The three property identification rule allows you to identify a maximum of three replacement properties notwithstanding their fair market value. Currently, the majority of real estate investors doing a 1031 exchange uses the three-property identification rule.
Under the three-property identification rule, you may decide to purchase all three of the identified properties but most investor tends to purchase one of the identified. The second and third identified properties usually act as backup properties if they are unable to close on the first property. If your goal is to identify more than three properties, then the 200% is your best bet.
- 200% Rule
The 200% rule allows you to identify multiple replacement properties as long as their aggregate fair market value doesn’t exceed 200% of the total fair market value of your relinquished property. While there is no limitation on the number of properties you can identify, the limitation is on the total value of the identified value.
For example, if you sold your relinquished property for $500,000, you can identify as many replacement properties but their total aggregate fair market value cannot exceed $1,000,000 which is 200% of your relinquished property.
- 95% Identification Rule
While this particular identification rule offers some benefits, it can be tricky if you are not familiar with it. The 95% identification rule allows you to identify more replacement properties irrespective of their aggregate total fair market value as long as you acquire and close on 95% of the replacement properties value identified.
However, if you are unable to acquire or close on at least 95% of the value of the identified replacement properties, the exchange will be disallowed.
There are benefits and challenges with each of these 1031 Exchange identification rules and requirements for replacement property. Before doing a 1031 exchange procedure, you should hire a reputable exchange company to help you with the process. Do not try this at home. Our experience is that for the few hundred dollars that you might save, it is better to hire an experienced qualified intermediary than suffer through the uncertainty of dealing with someone that is trying to reinvent the wheel.
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