A common source of confusion during the 1031 Exchange process centers around identifying a potential replacement property within 45 days of the sale of the relinquished property (or the property that was sold).
Investors often ask us, “what does identifying mean?” and “how many properties can I identify?” The answers to these questions are actually quite important because, under IRS rules, you are legally bound to purchase one of the properties that you “identify” or select during this process. So having a full understanding of what's required and taking your time to select wisely matters.
Three Strategies for Identification
Pick Three. Most commonly, investors will choose three properties to go on their identification form. The properties identified do not have to be capped at a specific value. That means, theoretically, you can sell a single-family home for $200,000 and tell the government that you are going to buy one of three apartment complexes that are each worth over $20 Million. This is an extreme example, but one that's permissible under this rule.
Stay Within 200% of Fair Market Value. The second rule is that you can list any number of properties on your sheet as long as their total does not exceed 200% of the fair market value of the property that you sold. So, let's go back to the property that you sold for $200,000 again as an example. If you were doing a 1031 Exchange, you could list up to $400,000 worth of real estate on your list and you could buy whatever you want off of it (whether that be a single property or multiple properties).
- Acquire 95% of Market Value. The third rule is that you can list any number of properties at any fair market value that you want, as long as you acquire 95% of the fair market value. However, this rule is rarely used because if your calculations are off by even a percentage point, you could end up in a lot of trouble.
The most important point to remember is that your identification sheet is not a wish list. You must end up buying one of the properties listed on the sheet in order to complete your 1031 Exchange. With that in mind, be sure to stay in close communication with your Exchange Agent as you are working to determine what you will purchase so he or she can help you narrow down the most realistic and beneficial options. If you have additional questions about this process or would like to speak to our Qualified Intermediaries about the 1031 Exchange process in general, please feel free to contact us at (888) 508-1901 to schedule a consultation.