1031 Exchange Identifications:
The Devil Is in the Details
For some Exchangers, identifying replacement property can be the most stressful part of the transaction. This article is intended to simplify the identification process by explaining the requirements and providing some tips to provide peace of mind.
The 45‑Day Identification Period requires you to identify, in writing, replacement property. The identification must be sent to 1031 CORP. before midnight of the 45th day after the relinquished property is conveyed to a buyer. If multiple assets are sold, the 45 days are triggered with the first conveyance. The 45-days are based on calendar days and not extended if the 45th day falls on a Saturday, Sunday or legal holiday.
There are limitations on the number of properties you may identify. These limitations apply regardless of the number of relinquished properties you sell in this exchange. The limitations are based on two rules:
The 3‑Property Rule allows you to identify up to three (3) properties regardless of their combined fair market value. You are not obligated to acquire all three properties but you must acquire at least one.
The 200% Rule allows you to identify four or more properties provided their combined fair market value does not exceed 200% (double) the fair market value of your relinquished property. The fair market value of the replacement properties is the listing or asking price of the property.
Identifying your Replacement Property
Your identification must be in writing and signed by you. Following are items to keep in mind when preparing your identification:
- Any real property held for business use or investment may qualify. The property may be located anywhere in the United States. Temporary regulations issued in 2005 allow the acquisition of rental properties in Guam, U.S. Virgin Islands and the Northern Mariana Islands.
- The property must be unambiguously identified using the street address or legal description of the property. If applicable, specific unit numbers are required.
- Your identification may be changed or additional properties added before midnight of your 45th day. It is essential to keep in mind the 3-Property Rule and 200% Rule. It may be necessary to revoke the original identification before making a new one.
- Any property purchased within the 45 days does not need to be formally identified, however, you must take it into consideration when identifying other properties.
- Acquiring replacement property from a related party should be given careful consideration.
NOTE: 1031 CORP. provides an identification form letter for your convenience.
Exchangers sometimes wish to use exchange funds to make improvements to the replacement property. The improvements must be identified and completed before you acquire the replacement property. This can be accomplished several ways.
- The improvements can be made by the seller and the sale price increased by the amount of the improvements. Typically, the Exchanger loans the money to the Seller and the improvements are completed before title is conveyed. It is always wise to have some form of security for the funds advanced to the Seller, such as a Note and mortgage.
- Minor repairs or improvements can be made by having the Exchanger, with the cooperation of the Seller, contract to have the improvements made prior to closing and having the invoice paid at closing.
- For more substantial improvements, there is a strategy called an Improvement Exchange. This type of exchange is more costly and requires significant planning to maximize its benefits. The Qualified Intermediary takes title to the replacement property directly from the Seller, contracts with the builder to construct the improvements, enters into an agreement with the Exchanger to act as the project manager and oversee the improvements and conveys the improved property to the Exchanger by the end of the 180-Day Exchange Period.
TIP: If contemplating using exchange proceeds to make improvements on your replacement property, please contact your Exchange Officer for more information.
Delivery of your Identification
Your letter can be faxed, mailed, hand-delivered, sent by overnight delivery or via email. To ensure the timely receipt of your identification, please note the following:
- Email: If you wish to email, be sure your letter is signed before scanning.
- Fax: If sending outside traditional business hours, we encourage you to fax to two different numbers. Be sure to retain a copy of your confirmation.
- USPS or Overnight Delivery: Letters mailed first class mail, certified mail or overnight delivery must be postmarked before midnight of the 45th day. Retain a copy of your receipt.
- In Person: Exchangers can personally hand deliver their identification to 1031 CORP.
NOTE: 1031 CORP. will send a written confirmation of receipt. Feel free to contact your Exchanger Officer for verbal confirmation.
Maximizing your Tax Deferral
To maximize your tax deferral, you should acquire replacement property of equal or greater value and equity than you had in your relinquished property. All Exchangers are encouraged to discuss your situation with your tax advisor.
Same Taxpayer Requirement
Title to both the relinquished and replacement properties must be held by the same taxpayer/owner. The only exception to this rule would be the use of a disregarded entity, such as a single-member limited liability company (LLC). If using a single-member LLC, the Taxpayer would have to elect to be taxed as a sole proprietorship. Except in a Community Property State, a husband and wife will be required to create two separate single member LLCs; one with the husband as sole member and one with the wife as the sole member. Each of the LLCs will acquire a 50% interest in the replacement property.
Some other disregarded entities, such as an Illinois Land Trust (Revenue Ruling 92-105) and a revocable living trust (Revenue Ruling 92-105, Revenue Ruling 70-376 and Revenue Ruling 88-103) will also qualify.
TIP: Your 1031 CORP. Exchange Officer is your partner in the 1031 exchange process and always available to answer questions or review an identification letter before finalizing it. When identifying outside traditional business hours, we always suggest you review a draft with your Exchange Officer before the close of business before your 45th day.