In any I.R.C. § 1031 Exchange, the correct and timely identification of replacement property is essential. Though there are a litany of 1031 exchange identification rules and regulations that must be followed exactly, there are some basics that must be understood from the beginning in order to execute a successful exchange. In a Forward (Delayed) Exchange, the Exchangor has a 45-day window after the closing of their relinquished property to identify potential replacement properties. This is commonly known as the “Identification Period.”
The Identification Period
The 45-day identification period begins on the day after the closing of the relinquished property. During this timeframe, the Exchangor must determine the replacement properties that they are considering for acquisition. Prior to the 45th day of the identification period, the Exchangor may add or remove identifications; however, on midnight of the 45th calendar day, no other properties can be added or removed. It is important to note that you must acquire a property that has been identified in writing prior to the close of the 45-day identification period. Though this timeframe is inflexible, there are two exceptions that could potentially extend the period: a Federally declared disaster or being called to support or be involved in an active combat zone.
During the 45-day identification period, the Exchangor must provide to the Qualified Intermediary (QI) a written document providing the unambiguous listing or address of the property or properties that the Exchangor is considering as replacement properties. This document must be signed, dated and provided to the QI via fax or email. Though it is possible to provide the 45 Day ID letter to another party in the transaction, such as the individual obligated to transfer the replacement property to the Exchangor (Seller of the replacement property) or another individual involved in the exchange such as a title company, it is considered best practice and the preference of Atlas 1031 Exchange to have the identification letter sent directly to the QI.
We’re commonly asked if the property has to be under contract by this period and the answer is no, the 45-day identification period is simply to unambiguously identify the potential properties in writing. It is fine if you are under contract; we find that it is a best practice to be searching for replacement properties well before the relinquished property closes.
In order to properly identify, there are three prevailing rules for how many properties can be included in the ID Letter.
The Three Property Rule
The Three Property rule is very simple and certainly the most commonly utilized 1031 exchange identification rule. An Exchangor can identify up to three properties “without regard to their fair market value,” meaning the Exchangor can identify up to three properties without concern to their value or the value of their relinquished property. This rule allows significant flexibility in identification and compliments real property that is sold with a lower gross sales price. Keep in mind that you are not obligated to acquire all three properties; however, in order to satisfy the 1031 exchange requirements, one or more of these properties must be your final replacement property.
The “200%” Rule
If you are interested in identifying more than three properties, the “200% rule dictates how you must identify. This rule allows you to identify four or more properties as long as their aggregate value does not exceed 200% of the gross sales price of the Exchangor’s relinquished property. This rule is very helpful to Exchangors who want to have as many options as possible, or if the gross sales price of the property is considerable and they are interested in acquiring multiple properties.
For example:
If Exchangor A sells a single-family home for $750,000 and is interested in utilizing the 200% rule, their identification could look similar to this example.
Property A: $150,000
Property B: $350,000
Property C: $500,000
Property D: $250,000
Property E: $250,000
Aggregate Total: $1,500,000
200% (Double) Relinquished Property Sales Price: $1,500,000
This Exchangor can now choose from any of the properties as long as their aggregate value is under $1,500,000.
As an aside, if the Exchangor closes on a property or properties during the 45 Day ID window, those values are still included in the total. If there are funds remaining and the Exchangor is submitting an Identification letter for the final consideration set of properties, they must take into account what has already been closed.
The 95% Rule
If your identification is greater than three properties and it exceeds the 200% aggregate rule, there is one final rule that can be adhered to for a successful exchange. The 95% rule allows for a successful exchange if the Exchangor receives 95% of the value of what was identified. In practice, this is very difficult to achieve and this rule is hardly ever utilized. Our recommendation is to simply adhere to the rules of the Three Property or 200% rule and avoid the usage of the 95% rule.
Replacement Property Acquired Within The 45 Day Period
In some instances, Exchangors will acquire their replacement property immediately after closing on their relinquished property or well before the 45-Day ID period concludes. In this instance, the property closed on is deemed to be properly identified and the ID letter is not required. We prefer to have the ID letter completed and submitted if the closing date is within 2 weeks of the 45-Day ID window close as a matter of protocol; however, it is not required.
Summary of 1031 Exchange Identification Rules
Keep in mind that in order to fully utilize the benefits of I.R.C § 1031, the replacement property must be equal or greater to the value of the relinquished property. Specifically, both debt and equity must be equal or greater to than that of the relinquished property. If this and the other aforementioned exchange rules are followed, the Exchangor will benefit greatly from the tax deferral made possible by a successful 1031 exchange.
We focus solely on accommodating 1031 exchanges and work alongside Exchangors every day to achieve successful 1031 exchange outcomes. Contact us today to discuss any questions you may have around the identification period or identifying future properties for your 1031 exchange. Call our office at 1-800-227-1031 or feel free to email us at info@atlas1031.com .
