How Do You “Identify” a Replacement Property for a 1031 Exchange?

Several strict requirements apply to like-kind exchanges under Section 1031. These include the requirement to “identify” a replacement property promptly. What does it mean to identify a replacement property—and how do you do it? Find out from a 1031 exchange expert at 1031 National Services:

What it Means to Identify a Replacement Property Under Section 1031

The requirement to identify a replacement property relates to the timing provisions of Section 1031. Specifically, Section 1031(a)(3) states that a replacement property will not qualify as a like-kind property if, “such property is not identified as property to be received in the exchange on or before the day which is 45 days after the date on which the taxpayer transfers the property relinquished in the exchange.”

As you can see, identifying a replacement property is key to establishing a taxpayer’s eligibility to conduct a like-kind exchange. Taxpayers must be prepared to demonstrate their eligibility to the Internal Revenue Service (IRS) if necessary, and demonstrating that they have timely identified a replacement property can be a key part of this process.

So, how do you “identify” a replacement property under Section 1031?

There are two primary options: The first option is simply to close on the acquisition of a replacement property. If a taxpayer conducting a 1031 exchange closes on the acquisition of a replacement property within 45 days of selling their relinquished property, this acquisition satisfies the identification requirement under Section 1031(a)(3). In this scenario, no further efforts to identify the replacement property are required.

The second option is to provide written notice to a qualified 1031 exchange intermediary. If a taxpayer intending to conduct a 1031 exchange is not prepared to close on the acquisition of a replacement property within 45 days, it must still identify a targeted replacement property within this timeframe. To identify a targeted replacement property, the taxpayer should provide written notice that includes the property’s legal description, including its street address, and any other information necessary to unambiguously specify the property targeted for acquisition.

Additional Considerations: Identifying Replacement Properties for an Anticipated 1031 Exchange

Let’s say you are planning to conduct a delayed exchange, which involves selling one property (the relinquished property) before acquiring another (the replacement property). Let’s also say that you aren’t planning to close on the sale of your replacement property within 45 days. You have informally identified a property you want to acquire, but, of course, there is no guarantee the sale will go through. What can (and should) you do in this scenario?

In this scenario, you will want to give yourself as much flexibility as possible (while still complying with Section 1031’s stringent requirements). There are three primary options:

• The Three-Property Rule – Under Section 1031, taxpayers can identify up to three potential replacement properties for a single proposed exchange. These properties can have any value, and taxpayers may acquire any one or more of them in the exchange.
• The 200-Percent Rule – Taxpayers also have the option of identifying more than three potential replacement properties. In this scenario, however, taxpayers must ensure that the combined value of the identified properties does not exceed 200 percent of the sales price of their relinquished property, unless the 95-percent exception applies.
• The 95-Percent Exception – The 95-percent exception allows taxpayers to identify four or more properties that do not comply with the 200-percent rule if they ultimately acquire 95 percent or more of the identified replacement properties.

Taxpayers can also retract and revise their replacement property identifications before the 45-day time window expires. So, if you begin identifying possible replacement properties promptly, it will help maximize your flexibility as well.

Another option that offers even greater flexibility is a reverse exchange. As its name suggests, this involves acquiring your replacement property before selling your relinquished property. If you are reasonably confident that the property you intend to relinquish will sell once it is listed, conducting a reverse exchange could be a good option.

Discuss Your Options with a 1031 Exchange Expert at 1031 National Services

If you need to know more about the requirements for conducting a 1031 exchange, we invite you to contact us for a free consultation. To speak with a 1031 exchange expert at 1031 National Services in confidence, give us a call at 888-872-1031 or request an appointment online today.