A 1031 exchange has several rules of operation that guide taxpayers looking to exchange their properties. One such rule is the 3-property rule, which prevents taxpayers from identifying more than 3 replacement properties. Despite this, however, can you identify more than three properties in a 1031 exchange?
Can You Identify More Than Three Properties in a 1031 Exchange?
Yes, you can identify more than three properties in a 1031 exchange. Although the 3-property rule states that taxpayers can identify only three replacement properties of any value, other rules -the 200% rule and the 95% rule- allow taxpayers to identify more than three properties.
Whether you are identifying three properties or more, all of them must meet the requirements of the Internal Revenue Service regarding property identification. If they do not, the transaction will be recognized as a taxable sale instead of a tax-deferred exchange, thus defeating the entire purpose of the exchange.
Rules for Identifying Property in 1031 Exchange
Several rules guide property identification in the 1031 exchange, the most basic of which states that all exchange properties must be of the same kind. If you plan on having a successful exchange, then it is vital you pay attention to these rules.
The 3-Property Rule
This is one of the most commonly used rules. This rule states that the exchanger has 45 calendar days from the closing date of the sale of the property they relinquished to identify a maximum of three replacement properties of any value, as long as they are of the same kind as the property that you are relinquishing.
The 200% Rule
This is a rule in the 1031 exchange that allows taxpayers to identify an unlimited number of properties provided their market value combined does not exceed 200% of the market value of the relinquished property, that is, double the market value of the relinquished property.
The 95% Rule
This rule is the least practiced because of the restrictions it places on the taxpayer. It states that as an investor, you can identify an unlimited number of like-kind replacement properties, without regard for valuation, provided the taxpayer acquires up to 95% of the total identified value of the targeted properties within the 180-day exchange period.
How to Carry Out a Property Identification in Northern Kentucky
In the 1031 exchange, a taxpayer is allowed to choose and modify their replacement properties as often as they choose during the 45-day identification period. This is achieved by unambiguously revoking the previous identification and subsequently identifying new replacement properties. All this must be done in writing, and then you should deliver on or before midnight of the 45th day.
Also, according to IRS requirements, signed property identifications should contain a detailed legal description of the property and are to either be delivered in person, mailed, or telecopied. The property identifications must be submitted to an involved party who is not the taxpayer or a disqualified person. The standard party who receives the document is the Qualified Intermediary.
Whether or not you are experienced in 1031 exchanges, it is advisable to seek the help of a professional and competent agency such as Si Vales Valeo Real Estate. We will provide you with guidance in identifying only ideal replacement properties, ensure you do not break any of the exchange rules, and ultimately conduct a successful 1031 exchange.
What Property Qualifies for Identification in a 1031 Exchange?
According to the Internal Revenue Service, the following properties qualify to be exchanged in a 1031 exchange:
- Raw land or farmland for improved real estate
- Residential, commercial, industrial, or retail rental properties
- Oil & gas royalties for a ranch property
- Simple interest fees in real estate, for example, a 30-year leasehold or,
- Tenant-in-Common interest in real estate
- Rental ski condo for a three-unit apartment building
- Mitigation credits for restoring wetlands for other mitigation credits
However, the following properties do not qualify for a 1031 exchange:
- Stocks in trade or any other property held primarily for sale i.e., property held by a developers
- Securities or other evidence of indebtedness or interest
- Stocks, bonds, or notes
- Certificates of trust or beneficial interests
- Interests in a partnership
- Rights to receive money or other property by judicial proceeding
- A second home or vacation home held strictly for personal use with no rental activity
- Foreign real property for U.S. real property
- Goodwill of businesses.
Related Questions
Do 1031 Exchanges Get Audited?
Yes, 1031 exchanges can be audited. According to the Internal Revenue Service, Section 1031 Exchanges are unaffected by any audit risk and can therefore be reviewed and audited. In fact, 1031 exchanges are one of the most reviewed tax cases because many taxpayers still default on the basic rules guiding the exchange.
Can a Family Member Live in a 1031 Exchange Property?
Yes, you are allowed to rent a 1031 exchange to a family member. According to IRS guidelines, renting your intended exchange property to a relative does not automatically disqualify you from tax deferment. However, it is paramount that you strictly adhere to the following rules:
- the rent charged should be the current market price for that property
- the rental agreement must be in writing and
- the taxpayer must implement the terms of the agreement, especially the clause about the late payment of rent.
The implication of allowing a relative to live for free or with reduced rent on a property intended for a 1031 exchange is that the property will not be considered as one held for investment purposes and, therefore, will not qualify for a 1031 exchange.
Can I Identify a Replacement Property That Is Under Construction?
Yes, you can identify a replacement property that is under construction. When doing this, you must include the address or legal description of the real property, as well as an unambiguous description of what you want to build.
Conclusion
Correctly carrying out the property identification process in any 1031 exchange is a factor that determines the success of an exchange. This article provides information that will help investors understand what property identification entails and how to successfully complete the process on time without breaking any rules.
