When engaging in a 1031 Exchange, the taxpayer must identify their replacement property(ies) within 45 days of closing on the sale of their relinquished property. This requirement raises a myriad of questions, such as: How exactly do I identify a replacement property? How many properties can I identify? Can I amend my identification list? Must I satisfy all 3 rules of identification? Which rule is best for me to use? We will attempt to address the answers to all of these questions and more below.
There are three (3) rules of identification, and the taxpayer must comply with one of the following three rules in order to satisfy the identification requirement:
- Three Property Rule: The taxpayer may identify up to three potential replacement properties without regard to fair market value. Note that this rule limits the number of properties that can be identified, but places no limit on the dollar value of those properties.
- 200% Rule: The taxpayer may identify more than three properties as long as their aggregate fair market value at the end of the identification period does not exceed 200% of the aggregate fair market value of the relinquished property as of the date of transfer. Note that this rule does not limit the number of properties that can be identified, but does place a limit on their cumulative dollar value (i.e. twice the sale price of the relinquished property).
- 95% Exception: The taxpayer may identify any number of properties, regardless of combined fair market value, on condition that the taxpayer purchases 95% of the value of the identified properties. Note that this rule does not limit the number of properties or their dollar value. However, the requirement that the taxpayer purchase 95% of the value identified will effectively mean (in most cases) that they must purchase every property they identify.
How do I identify my replacement property?
Most 1031 exchange qualified intermediaries send their client a form that they can use to identify their replacement property. The form must be filled out, signed, dated, and sent back to the QI within the 45 day identification period. The replacement property must also be unambiguously identified. This means listing either a street address, assessor’s parcel number (APN), block and lot, or legal description of the property being identified. If the taxpayer is purchasing a tenant in common (TIC) or other fractional ownership interest (such as a Delaware Statutory Trust), they must also indicate the percentage they intend to acquire. Also see our article on Identifying DSTs in a 1031 Exchange.
Can I amend or revoke my identification form?
The answer to this question depends on where the taxpayer finds themselves in the exchange timeline. If they are still within the 45 day identification period, the taxpayer may revoke or amend their identification form at will. However, once they are past the 45-day deadline, they can no longer amend or revoke their identification and must acquire one or more of the properties on the most recently submitted identification form in order to obtain tax deferral.
Which rule of identification is best for me to use?
The answer to this question depends mainly on how many replacement properties the taxpayer wishes to acquire. If their goal is to simply acquire one replacement property, then the three property rule will always provide the taxpayer with the most flexibility. If the taxpayer intends to acquire either 2 or 3 properties, then either the three property rule or the 200% will likely work best, depending on the value of the properties they intend to acquire. If the taxpayer intends to acquire 4 or more properties, then the 200% rule is likely best, unless the taxpayer intends to significantly buy up in value (in which case they may have to satisfy the stringent requirements of the 95% exception). It is recommended that a taxpayer speak with both their CPA and their 1031 qualified intermediary to assist in figuring out which rule will be most advantageous for a given exchange.
Can I extend the 45 day identification period?
The only time there is ever an extension of a taxpayer’s 45 day identification period (or the 180 day exchange deadline) is when there is a disaster extension under Rev. Proc. 2007-56. The IRS will explicitly issue a “Disaster Relief Notice” and will post it on their website. FEMA notices do not extend 1031 deadlines. See our article on 1031 Exchange Deadline Extensions for Natural Disasters. It is strongly recommended that a taxpayer confirm with their CPA whether a particular “Disaster Relief Notice” notice applies to their exchange.
Please speak with your tax advisor and contact one of our 1031 exchange experts for more details.
If you or someone you know has questions about the 1031 exchange process, we at Peak 1031 Exchange are your qualified experts who are here to help. Contact us today at [email protected] or by calling us at 866-357-1031 to discuss the deferral of capital gains taxes with a 1031 exchange.