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General Facts and Information
In order to complete a 1031 exchange, you must first identify the property that you want to exchange. This process is known as identification, and it must be done within 45 days of the sale of the original property. Once you have identified the property, you then have 180 days to complete the exchange. It is important to note that you cannot begin the process of identification until the sale of the original property has been completed.
These deadlines are in place to ensure that you have enough time to complete the exchange. If you do not follow the identification rules, the IRS could deem the exchange invalid, and you could face significant penalties.
In addition to following the deadlines, there are a few other key facts that you need to be aware of when it comes to identification.
3 Property Rule
One of the most important rules to be aware of is the three property rule. This rule states that you can only identify up to three properties, regardless of their value. This means that you cannot identify more than three properties, even if you do not plan on purchasing all of them.
In order to comply with this rule, you must list all of the properties that you are considering in your exchange agreement. You should also include a statement indicating that you are only identifying three properties, as well as their estimated market value.
200% Rule
The 200% rule is similar to the 95% rule, but it applies if the taxpayer wants to purchase more than 3 properties. This rule says that you can identify any number of replacement properties, but the total value of all the replacement properties cannot be more than 200% of the property you sold.
It is recommended that you identify properties worth less than what is allowed. This is in case some properties are later defined to have an increased value over what was originally estimated.
95% Rule
Another less common option is the 95% rule. This applies if your identification is greater than three properties and it exceeds the 200% aggregate rule. A successful exchange can occur if the Exchangor receives at least 95% of the value of what was declared. However, this rule is seldom used due to the difficulty and burden on the taxpayer.
Manner of Identification
The manner of identification is also important to be aware of. This rule states that the property must be identified in a specific way to be considered for the exchange. The most common way to identify a property is by providing the address and a description of the property in the exchange agreement.
You can also identify a property by using its tax identification number. This is known as the TIN method, and it can be used if you do not know the address of the property. However, you must still provide a description of the property in order to comply with this rule.
Reverse Exchanges
In some cases, you may want to complete a reverse exchange. This is when you purchase the replacement property before selling the original property. In order to do this, you must follow specific identification rules.
The first step is to identify the property that will be used as the replacement property. This can be done by providing the address and a description of the property. You can also use the TIN method, but you must still provide a description of the property.
Next, you need to identify the intermediary or exchange accommodation holder. This is the party that will hold the property until it is sold. It is important to note that this cannot be the same party who holds the replacement property.
Finally, you need to identify the reverse exchange accommodation provider. This is the party that will purchase the replacement property on your behalf.
Constructing Property
In some cases, you may want to construct a property as your replacement property. In order to do this, you must follow the same identification rules as if you were purchasing a pre-existing property.
This means that you must identify the property by providing the address and a description of the property. You can also use the TIN method, but you must still provide a description of the property.
It is important to note that you cannot begin construction on the property until after the sale of the original property has been completed.
Replacement Property
The replacement property is the most critical part of the exchange. This is because it is what you will receive in exchange for your original property. There are a few things to keep in mind when identifying the replacement property.
The first is that the replacement property must be of equal or greater value than the original property. This is known as the “like-kind” rule.
Second, the replacement property must be received within 45 days of the sale of the original property. If you do not receive the replacement property within this time frame, you will be considered to have failed the exchange.
For example, if you sell a property for $200,000 and do not receive the replacement property within 45 days, you will be considered to have failed the exchange.
Consider an exchange if you’re looking for a simple, low-cost way to defer capital gains tax on your property sale. The identification rules are relatively straightforward, and the process can be completed in 45 days or less. However, before beginning any type of 1031 exchange, it’s important to understand how they work so that you don’t run into any issues with IRS compliance down the road. Reach out to our team today for a consultation!