What Is the 200% Identification Rule in a 1031 Tax-Deferred Permit?

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May 6, 2022

Illustration of two houses swapping

The 1031 exchange is a process that enables owners of real estate properties to defer capital gains tax during the sale of one property to buy another one of the same kind. This exchange comes with many rules, one of which is the 200% identification rule. What is the 200% identification rule in a 1031 tax-deferred permit?

What Is the 200% Identification Rule in a 1031 Tax-Deferred Permit?

The 200% identification rule is perhaps the most common option for exchanging commercial properties under the 1031 exchange. According to this rule, a taxpayer can identify an unlimited number of replacement properties as long as their aggregate fair market value does not exceed 200% of the value of the relinquished property.

Man signing a document

In simpler terms, the 200% rule allows you to identify as many properties as you want, provided their cumulative value doesn’t exceed 200% of the property’s value. This rule is best for investors who are looking to identify more than three replacement properties, as opposed to the dictates of the 3-property rule. 

Asides from the 200% rule, the 1031 exchange has some other identification rules that have to be followed to ensure a successful exchange. They are:

  • The 45 days time limit to identify replacement property 
  • The 3-property rule
  • The 95% rule, which comes right after the 200% rule
  • The incidental property rule
  • Description of Replacement Property
  • Property to be reconstructed

This applies to all areas including the Cincinnati and Northern Kentucky area. 

Advantages of Practicing the 200% Identification Rule

Identifying ideal replacement properties is a vital decision for commercial real estate investors. Choosing the right commercial properties can ensure a smooth 1031 exchange. Choosing the wrong properties that are unable to close within the 180-day timeframe can hinder the 1031 exchange from full execution. 

This is where the 200% identification rule comes in. Here are a couple of advantages that the rule offers:

Ability to Identify More Than 3 Properties

Illustration of two houses swapping

Because of the risks that come with identifying a property that they cannot close on, investors would rather want to identify as many properties as possible than identify only a few. The 200% rule gives investors an edge over the 3-property rule which states that taxpayers can identify only three replacement properties of any value. 

The value of the identified properties must not exceed 200% of the value of the sold property before investors are allowed to exchange. This way, if one or two of your identified properties do not make it to closing within 180 days, the other chosen properties most likely will. Hence, you reduce the chances of having an unsuccessful 1031 exchange. 

No Minimum Criteria for Acquiring Properties 

Another 1031 exchange identification rule that enables investors to identify as many properties as they want is the 95% rule. However, this rule has a clause that you might find very restricting. It allows you to identify an unlimited amount of replacement properties, provided they are worth 95% or more of the total value. 

This means that you can only forfeit properties valued at 5% of the total value of identified properties, whereas, with the 200% rule, you are allowed to forfeit any number of chosen replacement properties if you cannot close on them within the given time. Hence, one less restriction with the 200% rule.

Helpful Tip

While identifying replacement properties, it is advisable to hire the help of a professional real estate agent, such as Si Vales Valeo Real Estate. Not only will they provide ideal replacement assets, but they would also see to a smooth transfer and closing, hence ensuring the success of your 1031 exchange.

Commercial real estate property

Related Questions

What Are the Reasons an Investor Might Consider Using a 1031 Exchange?

The main advantage of a 1031 exchange, as opposed to the traditional selling and buying of properties, is the provision it makes for investors to defer the payment of taxes. Aside from tax deferral, however, here are other reasons that should make you consider using the 1031 exchange rule:

  • It helps you to diversify assets. For example, if you own one apartment complex, you could choose to sell it to acquire more apartment complexes, hence helping you to build an impressive commercial real estate portfolio.   
  • It helps you to acquire properties that might offer higher returns
  • It allows you to avoid paying a higher tax on a property, as a result of depreciation recapture.

How Many Properties Can I Identify in a 1031 Exchange?

The number of properties you can identify while carrying out a 1031 exchange depends on the identification rule that you choose to follow. The 200% rule, for instance, allows you to identify as many properties as you want as long as their total value does not exceed 20% of the value of your sold property.  

How Long Does a Property Need to Be Held Before Doing an Exchange?

According to the tax code, there is no stipulated period for which an investor has to hold a property before replacing it using a 1031 exchange. However, a one-year hold period has been proposed by the government many times. To be on the safe side, it is best to have held the property for a year or more.

Conclusion

The 1031 tax-deferred exchange is a great opportunity for investors to acquire more properties for less. However, the process might be quite complex, especially for an investor acting alone, which implies hiring the services of professionals is a must. Si Vales Valeo Real Estate will be by your side throughout the 1031 exchange process and see it to a successful end. 

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