How to Use the 200% Identification Rule in a Reverse Exchange Under Revenue Procedure 2000-37

In a 1031 exchange, if you are parking the replacement property, the value of the identified relinquished properties cannot exceed 200% of the value of the replacement property.

Revenue Procedure 2000-37 states that:

• No later than 45 days after the transfer of the replacement property to the EAT, relinquished property must be identified in a manner consistent with the principles for identifying replacement property found in Treasury Regulation 1.1031(k)-1(c)(4).

The general consensus in the exchange industry is that an exchangor may identify more than one relinquished property, but the maximum number of relinquished property ties that a exchangor may identify is either three properties (determined without regard to the properties' fair market value) or any number of properties so long as the aggregate fair market value of the properties at the end of the identification period does not exceed 200 percent of the aggregate fair market value of the properties as of the date transferred. An exchangor may properly identify alternative and multiple properties.

In a typical forward exchange, identification is done in conformity with Section 1031(a)(3) that provides that replacement property received by the taxpayer is not treated as like-kind property if it:

• (a)  is not identified as property to be received in the exchange on or before the day that is 45 days after the date on which the taxpayer transfers the relinquished property (the “45-day identification period”); or

• (b) is received after the earlier of the date that is 180 days after the date on which the taxpayer transfers the relinquished property, or the due date (determined with regard to extensions) for the transferor's federal income tax return for the year in which the transfer of the relinquished property occurs.

Treasury Regulation 1.1031(k)-1(c)(4)(i) states that a taxpayer may identify more than one replacement property. Regardless of the number of relinquished properties transferred by the taxpayer as part of the same deferred exchange, the maximum number of replacement properties that the taxpayer may identify is:

• (A) Three properties without regard to the fair market values of the properties (the "3-property rule"), or

• (B) Any number of properties as long as their aggregate fair market value as of the end of the identification period does not exceed 200 percent of the aggregate fair market value of all the relinguished properties as of the date the relinquished properties were transferred by the taxpayer (the "200-percent rule").

Further, Treasury Regulation 1.1031(k)-1(c)(4)(ii) states that:

If, as of the end of the identification period, the taxpayer has identified more properties as replacement properties than permitted by paragraph (c)(4)(i) of this section, the taxpayer is treated as if no replacement property had been identified. The preceding sentence will not apply, however, and an identification satisfying the requirements of paragraph (c)(4)(i) of this section will be considered made, with respect to:

• (A) Any replacement property received by the taxpayer before the end of the identification period, and

• (B) Any replacement property identified before the end of the identification period and received before the end of the exchange period, but only if the taxpayer receives before the end of the exchange period identified replacement property the fair market vlaue of which is at least 95 percent of the aggregate fair market value of all identified replacement properties (the "95-percent rule").

For this purpose, the fair market value of each identified replacement property is determined as of the earlier of the date the property is received by the taxpayer or the last day of the exchange period.

Treasury Regulation 1.1031(k)-1(c)(4)(iii) 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 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.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2023 Copyright Jeffrey R. Peterson All Rights Reserved

Video - How The Tax Reform Act of 2018 Impacted 1031 Exchanges

The tax reform act of 2018 modified 1031 exchanges severely and limited the scope of 1031s to just real estate. Prior to 2018, we were able to do 1031 exchanges of other business equipment such as fleet automobiles, airplanes, railcars, etc. However, Congress has made the decision to limit the scope of this tax deferral to only real estate.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2023 Copyright Jeffrey R. Peterson All Rights Reserved

How to Know if Your Property Qualifies For A 1031 Exchange

If you are considering selling a piece of investment property and investing in another, you may wonder if the properties meet the eligibility requirements for a 1031 exchange. In order for this transaction to be eligible for 1031 exchange, the properties must be classified as “Like-Kind” properties. In the realm of real estate, the definition of “like-kind” is fairly broad in scope. Most investment real estate is considered like-kind to most other investment real estate. If you are selling some farmland and intend to purchase more farmland, you would be eligible to defer capital gains by pursuing a 1031 exchange since these are like-kind properties.

However, it’s important to realize that properties don’t need to be exactly the same in order for you to qualify for an 1031 exchange. After all, no two properties are exactly the same. This means that you could sell that same farmland and invest in a number of different properties besides farmland and still be eligible for a 1031 exchange. Below, we take a closer look at which properties qualify for a 1031 exchange and which ones would not.

Like-Kind Properties Explained

As we noted above, when performing a 1031 exchange, you must be buying and selling like-kind investment properties. In general, a real estate asset is considered “like-kind” to any other real estate asset so long as both are held for:

• Business or productive use in a trade

• Investment purposes

So in the farmland example, that farmland would be like-kind to a number of other assets, like an apartment or condominium rental. As long as they meet that threshold, the properties should be considered like-kind to one another.

There is a broad definition of what is eligible for a 1031 exchange, but not every single property is eligible. Some properties that would generally not be eligible for a 1031 exchange include:

• A primary residence

• Property that was held for resale (like a home you flipped)

• Personal property

• Foreign real estate

Of course, there can be some exceptions to these situations. Because of this, it is imperative that you work with a firm that understands the ins and outs of these exchanges. For more information, or to learn more about how we can help you with your asset exchange, reach out to CPEC1031 today at (612) 643-1031.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2023 Copyright Jeffrey R. Peterson All Rights Reserved

Video - Can You 1031 Exchange Between Residential & Commercial Property?

If you’re selling a commercial property, can you also do a 1031 exchange and purchase a residential property? The answer is almost all real estate in the United States is considered like-kind. Commercial, residential, retail, agricultural – it’s all real estate. So you can sell a commercial building and buy a residential property in a 1031 exchange. Remember, both the relinquished property and the replacement property must be held for investment or business purposes. So if you buy a vacation condo on the coast of Sanibel Island, you need to use it for investment or business purposes if you want to qualify for a 1031 exchange on that property. In a 1031 exchange you have to hold the property primarily for investment or business purposes in order to garner the lucrative tax deferral offered by section 1031.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2023 Copyright Jeffrey R. Peterson All Rights Reserved

Is There a 5-Year Ownership Period Required for 1031 Exchanges?

There is oftentimes confusion between the various rules and code sections applicable to different types of real property sale transactions. One of the more common questions we get is about a supposed 5-year ownership requirement. That’s our topic for this article.

Section 1031 Rules

There is no such 5-year rule under Section 1031 of the IRC. Section 1031 is for investment and business real property, and it states that:

• No gain or loss shall be recognized on the exchange of real property held for productive use in a trade or business or for investment if such real property is exchanged solely for real property of like kind which is to be held either for productive use in a trade or business or for investment.

So for Section 1031, one must have held the real property for the qualified purpose of “productive use in a trade or business or for investment,” and the length of time is somewhat undefined in the IRC. For more information, see this video.

Principal Residence Exclusion

Under another, different and unrelated rule, for personal-use property such as one’s home, the Principal Residence Exclusion under Section 121(a) states that:

• Gross income shall not include gain from the sale or exchange of property if, during the 5-year period ending on the date of the sale or exchange, such property has been owned and used by the taxpayer as the taxpayer’s principal residence for periods aggregating 2 years or more.

Under the In Principal Residence Exclusion for one’s home, there is a five year look back period; and in order to qualify for the exclusion, one must pass both ownership and usage tests: The two-out-of-five-year rule states that one must have: (1) Owned the property; and (2) Used as ones domicile (home) the property that is being sold for at least two years (24 months) in the five years prior to the sale closing. One can meet the ownership and use tests during different 2-year periods. However, one must meet both tests during the same 5-year look-back period ending on the date of the sale closing (when the benefits and burdens of ownership shift). Generally, one is not eligible to take the Principal Residence Exclusion if one has already excluded the gain from the sale of another home during the two-year period prior to the sale of your home. So one can only take advantage of the Principal Residence Exclusion every two years or more.

For more information See IRS Topic 701, and IRS Publication 523.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2023 Copyright Jeffrey R. Peterson All Rights Reserved