Replacement Property Identification

By Edward E. Fernandez | February 19, 2024

Couple viewing replacement properties.

Investors must adhere to very specific requirements for identifying and acquiring like-kind replacement properties in a 1031 exchange. Firstly, you must identify any potential replacement properties in writing via a signed document to your qualified intermediary, or accommodator, within 45 days after the closing on the sale of your relinquished property.

For instance, if the sale of your relinquished property closed on April 20, your 45 calendar day timeline to identify properties would begin on April 21, and your deadline would be midnight on June 5.

keep reading to choose an id strategy

Like-Kind Identification Rules and Exceptions

According to the IRS, a like-kind property is one that is of the same nature as the other, although they do not have to be the same in grade or quality. The nature of these properties generally refers to business, trade, or investment purposes. For example, you could exchange vacant land for an apartment building or a hotel for a medical complex. These types of properties fall under the category of growing capital, housing a business, or generating income through rentals.

Keep in mind that you may not exchange:

  • Personal residences
  • Properties held for resale, such as a “fix and flip” property

Additionally, foreign properties are not considered like-kind to U.S. properties and vice versa. Though you may perform a state-to-state 1031 exchange, your relinquished and replacement property must be in the United States.

Two of the most important rules for a 1031 replacement property are the 45-day and 180-day timeline. As noted above, you have 45 days to identify your new property or properties from the day you close on your relinquished property. From the day you sell your relinquished property, you also have 180 days to close on one or all of the identified properties. 

For example, if you identify your replacement property on the 45th day, you now have 135 days left to close on that property. You must also identify your property in writing with a legal description or street address and deliver it to your intermediary.

Within the 45-day timeline, you can change your identified property as many time as you wish.

However, within the 45-day timeline, you can change your identified property as many times as you wish. For instance, if you identify a qualified replacement property within 20 days but find a better deal on the 30th day, you can substitute the property and revoke the previous one.

For a replacement property to be considered eligible for a like-kind exchange, it must also be equal or greater in value than your relinquished property. Otherwise, any proceeds you have left over that do not get reinvested into your replacement property will be characterized as a taxable sale.

When identifying your like-kind replacement properties, you must also comply with at least one of the following 1031 identification rules or exceptions, or your exchange may be disallowed.

Three-Property Identification Rule

3 property id rule

The three (3) property identification rule states that investors performing a 1031 exchange are limited to identifying three potential like-kind replacement properties for the transaction. Most investors today use the three-property identification rule.

You are not required to acquire all three properties as part of your 1031 exchange. However, you must acquire at least one of the properties you identify. The other two properties give you a fallback plan in case the first property deal falls through, allowing you to go with one of your backup properties.

For example, you might find a suitable multifamily property that is equal or greater in value to your relinquished property close to the 45-day deadline. However, there is always the risk that the sale could fall through. To avoid a failed 1031 exchange, many investors take advantage of the three-property rule to have additional options available since they do not have to acquire all three properties.

If you want to diversify your real estate investment portfolio, you may be able to identify more than three like-kind properties with the following exceptions.

200% of Fair Market Value Identification Rule

200% of fair market value

Often called the 200% rule, this strategy is an exception to the three-property rule that investors can use to expand their replacement property options. This rule for a 1031 replacement property states that you are not limited to three replacement properties. However, the total, or aggregate, fair market value of all the properties must not surpass 200% of the total net sales of your relinquished property or properties. Though there is a limit on the aggregate value of the identified properties, investors can identify as many properties as they wish.

For example, if you sold relinquished property or properties in the amount of $2,000,000, you could identify six or seven properties as long as their aggregate value does not exceed $4,000,000 (200% of $2,000,000). 

This strategy can give investors more flexibility when searching for properties. If you choose to comply with this rule, know that it takes careful planning and coordination to ensure you do not exceed the 200% limit.

95% Identification Exception

95% id exception

The 95% rule can be an exceptionally useful tool under the right circumstances, but it can also present some tricky problems. Similar to the 200% rule, the 95% rule is another exception to the three-property identification limit. 

You may need to identify significantly more like-kind replacement properties than the first two 1031 replacement property rules permit. As with the 200% rule, you are not limited to the number of replacement properties you can identify, but you must actually acquire and close on a minimum of 95% of the value of those properties. For instance, if you identify five like-kind replacement properties, you must close on 95% of the total value of the five properties.

However, if you do not acquire and close on at least 95% of the value of the identified like-kind replacement properties, the entire 1031 exchange transaction will be disallowed.

Explore 1031 Exchange Approved Properties With 1031 Crowdfunding

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Performing a 1031 exchange can provide a tremendous increase in purchasing power, enabling you to increase your cash flow and diversify into new asset classes. Because there are many components to a successful like-kind exchange, being well-prepared with a backup option can prevent you from getting hit with a capital gains tax bill.

For investors who are challenged with the strict 45- or 180-day timelines, the professionals at 1031 Crowdfunding are here to help. Our Delaware Statutory Trusts (DSTs) can close within 3-5 days. We like to consider DSTs as a backup plan because there is no guarantee that the investor will be able to close on their first choice, or possibly even their second-choice property in this competitive real estate market. Therefore, we suggest considering one of our DST properties as a third option.

Create an account to browse our 1031 exchange approved properties today.

This material does not constitute an offer to sell or a solicitation of an offer to buy any security. An offer can only be made by a prospectus that contains more complete information on risks, management fees and other expenses. This literature must be accompanied by, and read in conjunction with, a prospectus or private placement memorandum to fully understand the implications and risks of the offering of securities to which it relates. As with all investing, investing in private placements is speculative in nature and involves a degree of risk, including loss of your principal. Past performance is not necessarily indicative of future results and forward-looking statements and projections are not guaranteed to achieve the results described and your actual returns may vary significantly. Investments in private placements are illiquid in nature and there may be no secondary market or ability to sell the investment should the need for liquidity arise. This material should not be construed as tax advice and you should consult with your tax advisor as individual tax situations will vary. Securities offered through Capulent, LLC Member FINRA, SIPC. 

 

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