Note: This is a continuation of our previous article: A Primer on 1031 Identification Rules.
What Are the Required Elements for a Valid ID?
In a 1031 exchange, your replacement properties should be:
- Clearly and specifically (unambiguously) designated
- In writing
- To the qualified intermediary (or other person involved in the exchange who is not disqualified)
- Using the postal address(es) of the property (including House/Building Number, Street Name, City, County, State, and Zip Code), and/or the complete legal description (including the Metes and Bounds description, or Lot and Block or Other Subdivisions, or Condominium Unit Number and Name) and/or the County Tax Assessor's Parcel Number (APN, PID or Property Tax Identification Number) or you can use the property’s distinctive name, such as “The Empire State Building”
- Sent before Midnight of the 45th day after the closing of the sale of your relinquished property
Generally, the more specific the identification the better. The more general or less specific, the more risk that the 1031 exchange could be disallowed during a federal or state audit.
1031 Best Practices for Sending-in an ID
The most common and safe practice is to use a qualified intermediary and to fax or otherwise send in your 1031 replacement property identification form early; then ask your qualified intermediary to send you back written confirmation that they have received it. On IRS form 8824, which is a worksheet that you attach to your federal tax return to give the IRS information about your exchange, question 5 requires you to provide the “date” the like-kind property you received was identified by written notice to another party (month, day, year).
If you are ever audited by the IRS, is important to have a good records on When, How and to Whom you sent your identification to so that you can substantiate the information in your federal tax return and on IRS Form 8824. For an extra level of thoroughness, in addition to faxing or e-mailing a signed PDF of the 1031 replacement property identification form, you may also send the identification to the qualified intermediary through the US Postal Service by First Class Certified Mail Return Receipt Requested.
That way you can keep the Return Receipt as proof that you sent it, and further, your qualified intermediary can retain the postmarked envelope as proof of when it was sent. Make sure that you take your letter to the US Postal Service and have it postmarked (legibly) before the 45th day. If you simply drop your letter into a mailbox, it may not be picked-up, processed and postmarked by the US Postal Service with the same date that you actually dropped it into the mailbox.
Is Signing a Purchase Agreement for Replacement Property Sufficient to Constitute an Identification for 1031 Purposes?
As noted before, a taxpayer can technically identify to the seller of the replacement property as long as it is done within the 45 day identification period in a written document and meets the other requirements for a valid designation. If you want your purchase agreement to constitute an identification of replacement property (which is an uncommon but permissible practice) you may want to clearly state your intention by including text in the purchase agreement such as:
“The Seller acknowledges that the Purchaser herein designates that the subject property shall be the Purchaser’s replacement property to complete the Purchaser’s like-kind exchange of property under Section 1031 of the Internal Revenue Code regarding Purchaser’s disposition [insert address] as relinquished property.”
How Many Replacement Properties Are You Allowed to Identify?
The treasury regulations contain restrictions on the number of properties which can be identified as potential replacement properties. Multiple potential replacement properties can be identified as long as you satisfy one of these ALTERNATIVE rules:
- The Three-Property Rule - Up to three properties regardless of their market values. All identified properties are not required to be purchased to satisfy the exchange.
- The 200% Rule - Any number of properties as long as the aggregate fair market value of all replacement properties does not exceed 200% of the aggregate Fair Market Value (FMV) of all of the relinquished properties as of the initial transfer date. All identified properties are not required to be purchased to satisfy the exchange.
- The 95% Exception - Any number of replacement properties if the fair market value of the properties actually received by the end of the exchange period is at least 95% of the aggregate FMV of all the potential replacement properties identified. In other words, 95% (or nearly all) of the properties identified must be purchased or the entire exchange is invalid.
NOTE: The replacement property that you receive should be “substantially the same” as property that you identified within the 45-day Identification Period. If you do not buy substantially the same property, then your replacement property may not be considered like-kind for 1031 exchange purposes.
What if I am Doing a Build-to-Suit?
If you are going to conduct a build-to-suit exchange wherein your qualified intermediary or exchange accommodation title-holder is taking title to the new replacement property while new improvements are constructed, then you should designate in your replacement property identification not only the initial replacement property, but also the new like-kind improvements that will be completed and received by you with the 180 day exchange period.
What If I Change My Mind – Can I Revoke or Revise My Identification?
During the first 45 days after the closing of your relinquished property (the Identification Period), you are free to revoke or change your 1031 Replacement Property Identification provided that it is done in writing, signed by the taxpayer and it is sent to the qualified intermediary (or other person involved in the exchange that is not disqualified) that you identified to previously. If you do revise your Identification to add new properties to your list (to remove and replace other previously listed properties), then you may want to make it clear that your subsequent Identification supersedes and replaces any prior designations by writing that on the last Identification. Otherwise, it may be unclear if your subsequent Identification is intended to add more properties (potentially pushing you over the Three-Property Rule or 200% Rule).
After the 45th day of the exchange, the only properties that will be considered like-kind (once the 45th day has elapsed and the Identification Period is over) are those properties that were properly designated. You are not allowed to change your 1031 Replacement Property Identification after the 45th day, so if a better property comes along that you would prefer to purchase, you are S-O-L (Statutorily Out of Luck).
- 1031 Hotline: If you have questions about 1031 identification best practices, feel free to call me at 612-643-1031.
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