Most of you are aware that the taxpayer/exchanger has 45 days from the day of closing, the day of closing being the first day, to identify possible Replacement Properties when using a 1031 Exchange transaction to defer taxes.
When the time comes to identify those possible Replacement Properties, there are 3 different identification rule options: (1) The 3 Property Rule; (2) The 95% Rule; and (3) The 200% Rule.
The Identification Rule that is chosen the most is The 3 Property Rule because it is the easiest and gives exchangers more options. There are NO dollar restrictions when using this Identification Rule. The Only restriction is that you can only identify up to 3 different properties as possible Replacement Property.
The best way to explain this rule is with an example. For this example, I am going to use a recent 1031 exchange that was handled in our office.
Taxpayers transferred (sold) their Relinquished Property, which was a duplex they had owned for 4 years. They originally had purchased this property for the sum of $229,000. Their purchaser was now paying the sum of $450,000.00, so they had on paper, without any of the standard deductions, a profit of $221,000.
For a good dissertation on what deductions are allowable, review our recent post titled ‘What Expenses are Deductible On A 1031 Exchange?”
Liberty 1031, LLC reminded our clients/exchangers that they had to purchase one or more Replacement Properties for at least $450,000.00 and use all of the proceeds from the transaction if they did not want to have to pay any taxes to the “Tax Man”.
They closed on their Relinquished Property transaction and then e-mailed their Identification Statement to us on day 44, even though they had till day 45 to send it to us. Although they didn’t have to identify 3 properties, in their case they did. The 3 properties were: a warehouse for $560,000; a townhouse for $350,000; and a condominium for $209,000.
If they purchased the warehouse for $560,000, that of course would qualify, because the cost was more than the investment property they had relinquished. If they purchased either the townhouse for $350,000 or the condominium for $209,000, they would not have purchased something of equal value or more and therefore they would have to pay tax on the difference. But the rest of the funds would qualify for a “partial exchange”.
They could also purchase both the townhouse for $350,000 and the condominium for $209,000 for a total of $559,000, which of course is more than the $450,000 that they sold their Relinquished Property for; this would also qualify for a complete tax-deferred exchange.
They had a lot of options and because they used The Three (3) Property Rule, they had a choice of which properties to purchase. I want to repeat that they did have one limitation; they could only identify up to 3 properties.
You can learn more about the Identification rules and how the taxpayer can identify more than 3 properties at our website here. You can also learn more about the 200% Rule and the 95% rule, from the examples in this previous post titled Everything You Need to Know About 1031 Exchange Property Identification.
LIBERTY 1031, LLC always recommends that the taxpayer should consult their tax and/or legal counsel on all matters dealing with the Internal Revenue Service.I personally look forward to working with you on your next Section 1031 exchange. To answer any of your questions or to open a Section 1031 transaction, please contact Stephen A. Wayner, Esq. CES at our toll-free telephone number: 866-903-1031 or at firstname.lastname@example.org.