The seller has an identification window of 45 calendar days to identify a property to complete the exchange.
Once this window closes, the 1031 exchange is considered failed and funds from the property sale are considered taxable.
Due to this slim window, investment property owners are strongly encouraged to research and coordinate an exchange before selling their property and initiating the 45-day countdown.
Fortunately, investors have multiple identification strategies available, which are summarized in three rules:
Three Property Rule
Also known as the Three Property Identification Rule, the Three Property Rule enables investors to identify up to three like-kind replacement properties, whatever their fair market values are. After identification, the investor could then acquire one or all of the three identified like-kind replacement properties through the 1031 exchange process. This method is the most popular 1031 exchange strategy for investors, as it allows them to have backups if the purchase of their preferred property falls through.
The 200% of Fair Market Value Identification Rule states investors can identify an unlimited number of like-kind replacement properties, provided the total value of all properties at the end of the period doesn’t exceed 200% of the relinquished property’s total net sales value.
If an investor wants to perform a 1031 exchange on a property with a sales value of $1 million, they can identify as many replacement properties as desired as long as those properties’ total value doesn’t exceed $2 million. This strategy is often preferred by investors looking to acquire over three investment properties or seeking extra backup properties if a sale falls through.
The 95% Identification Exception states investors can identify an unlimited number of potential replacement properties with an unlimited fair market value, provided the investor acquires and closes on 95% of the identified market value. This technique is most often used by investors who exceed the 200% rule at the close of the identification period.
Using this exception may be an intentional choice if the investor seeks to purchase multiple properties. It may also happen inadvertently from sudden property value increases. Either way, this gets around the 200% rule while still meeting 1031 exchange requirements.
It’s important to note that if the investor fails to identify properties or identifies more properties than allowed by the Three Property Rule or the 200% Rule and cannot apply the 95% Exception, then the 1031 exchange is considered failed.