1031 Exchange regulations allow taxpayers to defer capital gains taxes on the sale of business or investment real estate, provided the funds are utilized to acquire a like-kind property within 180 days. While that may sound simple, there are some very specific requirements that must be met during those 180 days.
A crucial rule to note is that the exchanger must identify any potential replacement property(ies) within 45 days of the relinquished property closing date. Knowing the ins and outs of this 45-day identification requirement might help you get the most out of your 1031 exchange. Below are some Frequently Asked Questions about the 45-days identification period.
What is the 45-day Identification Period?
The 45-day time period spans from the date of the sale to midnight of the last day. The identification should be a written document signed by the taxpayer, and the replacement property seller needs a copy. The contract identifies whether the commercial real estate meets the rules. A disqualified seller may bend the rules because of a relationship with the taxpayer. Only qualified sellers count during the 45 days.
What is the Typical 45-day Identification Rule?
The following are the rules for selecting replacement properties, according to Section 1031 of the US Tax Code and associated regulations:
- The identification must be made in writing, signed by the exchanger, and sent to the qualified intermediary or other exchange parties by midnight 45 days from the date the relinquished property is transferred, regardless of weekends or holidays.
- The property must be identified in a clear and unambiguous manner.
- Any property acquired during the 45-day identification period is deemed identified and counts toward the total number of properties eventually identified during the 45-day period.
- If more than three properties must be recognized, additional restrictions will apply.
What is the Three-Property Rule?
The three-property rule allows the selection of replacement property to be three properties regardless of the property's fair market value. A rule stated that 1031 trades prioritized recognized properties. Taxpayers were unable to identify another property until the initial property transaction was completed.
What Are The 200% And 95% Identification Rules?
The 200% rule permits a taxpayer to identify properties as long as the total fair market value of the properties being relinquished does not exceed 200% of the value of the properties being abandoned. During the 45-day identification phase, the regulation applies to designated commercial real estate. When analyzing a property, using the listing price is a safer bet, but determining the market value is difficult. According to the 95% rule, an over-identified property may still be acceptable if the taxpayer obtains at least 95% of the value.
What are the Penalties for Not Complying with the 45-day Rule in a 1031 Exchange?
As a real estate investor, you're probably aware of the many benefits of a 1031 exchange, including tax-deferred income and the ability to reinvest your profits into new properties. However, it's important to comply with the rules and regulations of the exchange process.
The penalties for not complying with the 45-day rule can be significant, including the potential loss of tax deferral benefits and additional tax liability. In addition, the IRS can impose penalties and interest on any tax owed, as well as audit your tax return and assess additional penalties if they find any discrepancies.
To avoid these penalties, it's essential to work with a qualified intermediary and your team of advisors to follow the 45-day rule carefully. By doing so, you can enjoy the many benefits of a 1031 exchange and ensure a successful and tax-efficient exit from your investment property.
What If I Can’t Find A Suitable Replacement Property By Day-45?
If you do not find eligible replacement properties by the deadline, you will forfeit your opportunity to complete your 1031 exchange. That is why it is vital to collaborate with the right individuals from the start and to choose alternative properties wisely. Begin looking even before your relinquished property is sold so you don't waste time hunting for the perfect replacement property.
As a backup, a DST can be an excellent choice. Delaware Statutory Trusts are a type of real estate holding structure that allows many buyers to buy an interest in a property that is frequently larger than they could buy on their own, without requiring them to be active managers. Even better, this structure qualifies as like-kind replacement property in a 1031 exchange, and the DST sponsor bears the burden of negotiating the buy and sale agreement, which is why many exchangers include a DST on their list of suitable properties.
If you miss the strict 45-day deadline, all is not lost. You may not be able to delay taxes through a 1031 exchange, but there are other tax-advantaged techniques stashed away in the Internal Revenue Code. For example, Opportunity Zone assets can be utilized to delay capital gains taxes not only from the sale of real estate but also from the sale of stocks or businesses. Deferred Sales Trusts and Structured Installment Sales are also worth consideration. Deferred Sales Trusts, allow you to purchase real estate without the 1031 exchange hurdles, identification timelines, and replacement property purchase time periods. Structured Installment Sales let you structure your income over time, rather than receiving it all at once.
Can the 45-Day Rule in a 1031 Exchange be Extended?
Yes, the 45-day rule in a 1031 tax deferred exchange can be extended under specific circ*mstances. The IRS allows for an extension of the 45-day identification period in cases of natural disasters, presidentially declared disasters, or terroristic or military actions. In such scenarios, the exchange period can be extended to a reasonable period that does not exceed 120 days from the original deadline. It's essential to note that the extension is not automatic, and you must provide written documentation of the specific circ*mstances that caused the delay. In addition, you must request the extension before the 45-day period expires. Failing to comply with these requirements and deadlines can result in the disqualification of your 1031 exchange. Therefore, it's crucial to work with a qualified intermediary and a tax professional to ensure that you follow the rules and maximize the benefits of your exchange.
Doing 1031 Exchange Property Identification the Right Way
One rule regarding deferred 1031 exchanges that absolutely must be followed is that you need to work with a Qualified Intermediary. The QI performs several important jobs, not the least of which is holding proceeds from the relinquished property until the replacement property is acquired.
If you want things done right, you need to work with an experienced partner, and the Sera Capital team has decades of experience, with thousands of successful transactions, as well as specific expertise in Opportunity zones and DSTs. By combining our elite expertise with our fee-only fiduciary strategy, Sera Capital offers its 1031 exchange clients the ultimate in security, transparency, and compliance.
Please note - Sera Capital is not a qualified intermediary, facilitator, or accommodator (for those out west). We always want to avoid that conflict of interest between making investment recommendations and holding onto investors' money. We are fee-only fiduciary advisors who sell DSTs, QOZ, and the other IRC Section 453 investments used to defer capital gains. Sera Capital is a wealth management consulting firm specializing in all aspects and all available tax-efficient exit options for business owners, real estate investors, and developers. Our team works with you and your advisors to examine all available solutions, including 1031 Exchanges, Delaware Statutory Trusts, 721 UPREITS, Opportunity Zone Funds, and Section 453 Installment Sales, including Deferred Sales Trusts and Structured Installment Sales. We have two mottos. The first is “We help landlords and business owners exit tax efficiently,” and our second is “When you want out, call us in.”
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