Missing the 45-day deadline or identifying a replacement property incorrectly can derail your 1031 Exchange. David and Tom Moore, co-founders of Equity Advantage known as The 1031 Exchange Bros., explain when the deadline begins, how the 1031 Exchange 45-day identification rules affect which properties an investor can buy, and major mistakes to avoid when choosing properties.
The 45-Day Clock Starts When the Sale Closes
Contrary to what you might think, signing a sales contract does not actually start the identification period for a 1031 Exchange. Closing the sale of the relinquished property does. David and Tom generally consider the closing date to be the settlement date on the final escrow statement. That date then marks the beginning of both the 45-day identification period and the 180-day period for completing the Exchange.
You may notice that the date on the deed is different from the final escrow date. Tom cautions against relying on the recording date alone because it may not reflect when the buyer took on the benefits and burdens of ownership.
If you sell near the end of the year, your 180-day Exchange period may extend past the due date for that year’s tax return. In that case, Tom says you may need to file for a tax return extension so you can complete the purchase within the 180 days.
Identify a Property, Not Just an Area
Within 45 days, submit a signed, written identification of the specific properties you may buy. Include enough detail to identify each one, such as its address and, for a condo, its unit number. Listing only a city or county is not enough.
You can list several properties, but there are three main rules to follow:
- Three-property rule: Identify up to three properties, regardless of their value.
- 200% rule: Identify more than three properties if their combined value is no more than twice the value of the property you sold.
- 95% rule: If you go beyond both of those limits, buy at least 95% of the total value you identified.
The 95% rule gives you much less room for a purchase to fall through. Say you identify five properties whose combined value exceeds twice the value of the one you sold. You may need to buy nearly all five. If you cannot close on one of them, the entire Exchange could fail.
Values matter under the 200% rule too. David and Tom warn against listing unrealistically low values just to stay under the limit. That could create a problem if you later pay more for those properties.
The three-property rule gives you room to name backups. Say you sell a $500,000 rental and want to buy one replacement property. You can identify three possible purchases, even if each costs more than $500,000. You do not have to buy all three; you can choose among them as the purchases move forward.
A DST Can Count as One Identified Property
Another option for an investment property is buying an interest in a Delaware Statutory Trust (DST). Even if the DST owns ten properties, you are buying an interest in the whole trust, not buying its properties separately. When the offering is sold as a whole, identify the DST and the percentage interest you plan to buy. This can be treated as one of your identified properties.
Plan for Any Money Left After Your Replacement Purchase
Buying a replacement property does not always use all the money held for your Exchange. If there is cash left after the purchase closes, you may want it back. When Equity Advantage can return that money depends in part on what you said you would buy on your identification form.
Say you sell a rental property, and Equity Advantage receives $480,000 from the sale for your 1031 Exchange. You identify three possible replacement properties, but you plan to buy only one. You buy it for $450,000, leaving $30,000 in the Exchange account. When can you get that money back?
The answer depends on the plans you make when identifying your replacement properties. For example, Equity Advantage’s identification form lets you state that you will buy no more than one of the properties on your list. Once that purchase closes and the 45-day identification period has ended, Equity Advantage cannot buy either of the other properties for you, so it can return the remaining $30,000. Tom says money you take out of the Exchange is taxable.
Without that limit on the form, you could still buy another property from your list. Equity Advantage cannot simply return the money because you ask for it. There are rules about when an exchange company may release funds it has received.
If you already know you want to keep some cash from the sale, David and Tom describe another option: arrange for that amount to go directly to you at closing, before the Exchange proceeds reach Equity Advantage. That amount is treated as taxable proceeds.
Make the 45 Days Count for your 1031 Exchange
You may have three promising properties in mind on day one, but a lot can change before you close. The identification form is where you decide which of those possibilities you can still pursue through the Exchange. Give yourself time to talk through the choices before the 45 days are up.
If you are working toward a 1031 Exchange, contact Equity Advantage to discuss your options and make an identification that fits the purchases you actually hope to make.
The Guys With All The Answers…
David and Thomas Moore, the co-founders of Equity Advantage & IRA Advantage
Whether working through a 1031 Exchange with Equity Advantage, acquiring real estate with an IRA through IRA Advantage or listing investment property through our Post 1031 property listing site, we are here to help Investors get where they want to be. Call them today! 503-635-1031.
FAQs About 1031 Exchanges and the 45-Day Identification Period
When does the 45-day identification period start?
It starts when the sale of the relinquished property closes. David and Tom look at the settlement date on the final escrow statement to determine that date.
Can I identify a city or county under the 1031 Exchange 45-day identification rules?
No. You need to identify a specific replacement property. For a condo, that means specifying the unit you might buy.
Do I have to buy every property I identify?
Usually, no. You can identify alternatives under the three-property or 200% rule. If you rely on the 95% rule, however, you must buy at least 95% of the total value identified.
