Do the properties that I receive title to (by closing on) within the 45 day identification period reduce the number of additional replacement properties that I may identify or designate in writing under the Three-Property Rule, 200% Rule, or 95% Exception?
Internal Revenue Code
Internal Revenue Code Section 1031(a)(3) imposes both the 45 day Identification requirement and the 180-day due-date for federal tax return exchange period.
Treasury Regulation 1.1031(k)-(c) provides information on how to make your identification of replacement property before the end of the identification period. It states that:
(1) In general. For purposes of paragraph (b)(1)(i) of this section (relating to the identification requirement), replacement property is identified before the end of the identification period only if the requirements of this paragraph (c) are satisfied with respect to the replacement property. However, any replacement property that is received by the taxpayer before the end of the identification period will in all events be treated as identified before the end of the identification period.
As the properties that you actually receive within the 45 day identification period are treated or deemed as identified, these ‘received properties’ must also be included in computing the various identification rules (e.g., the Three-Property Rule, 200% Rule or 95% Exception). This predicament is described in an illustration set out in Treasury Regulation 1.1031(k)-(c)(4)(iii) which states that:
For purposes of applying the 3-property rule, the 200-percent rule, and the 95-percent rule, all identifications of replacement property, other than identifications of replacement property that have been revoked in the manner provided in paragraph (c)(6) of this section, are taken into account. For example, if, in a deferred exchange, B transfers property X with a fair market value of $100,000 to C and B receives like-kind property Y with a fair market value of $50,000 before the end of the identification period, under paragraph (c)(1) of this section, property Y is treated as identified by reason of being received before the end of the identification period. Thus, under paragraph (c)(4)(i) of this section, B may identify either two additional replacement properties of any fair market value [*under the Three-Property Rule] or any number of additional replacement properties as long as the aggregate fair market value of the additional replacement properties does not exceed $150,000 [*under the 200% Rule]. *emphasis added
Remember that your 1031 proceeds from the disposition must be re-invested in like-kind properties within 180 days of the transfer of your first relinquished property. These properties will only be considered to be like-kind if they are properly identified according to Treasury Regulation 1.1031(k)-(c)(4) which imposes limitations on the number of properties which can be identified as potential replacement properties.
Alternative 1031 Rules
More than one potential replacement property can be identified, provided that 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; only the amount needed to satisfy the value requirement.
- 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; only the amount needed to satisfy the value requirement.
- 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 almost all) of the properties identified must be purchased or the entire exchange is invalid [except for any Replacement Property actually received within the 45 day identification period].
NOTE: The replacement property received must be substantially the same as property identified within the 45-day limit described above.
- 1031 Hotline: If you have questions about 1031 identifications, feel free to call me at 612-643-1031.
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