What you need to know about Identification Rules for Exchanges…Generally.
The taxpayer has 45 days from the date of the closing of the sale of the Relinquished Property(ies) to identify the Replacement Property(ies) that he/she intends to acquire for the exchange. Not all of the Replacement Property(ies) identified need to be acquired, however, the tax payer is not allowed to acquire property other than the Replacement Property(ies) identified and a failure to comply with any of the identification rules can disqualify the entire 1031 exchange transaction. The taxpayer may change the identified properties as long as it is done so within the 45 day identification period.
3 Property Rule.
The 3 Property Rule is the most commonly used rule. The taxpayer may only identify up to three Replacement Properties and may acquire one, two or all three of such properties.
200% of FMV Rule.
If the taxpayer wishes to identify more than three Replacement Properties, he/she can use this rule. The taxpayer is allowed to identify any number of Replacement Properties provided that the total fair market value of the properties identified does not exceed 200% of the total fair market value of the Relinquished Property.
The taxpayer may identify as many Replacement Properties as he/she chooses under this rule (there is no number or value limit), provide that the taxpayer must actually acquire and close on at least 95% of the value identified. If the taxpayer does not acquire and close on at least 95% of the value of the identified properties, the entire 1031 exchange transaction will be disallowed.
Acquired in 45 Day Period.
Any property acquired by the taxpayer during the 45 day identification period is deemed to be properly identified.
The identification must (i) appear in a written document, (ii) be signed by the taxpayer, and (iii) delivered to the Replacement Property seller or any other person involved in the exchange who is not a “disqualified person”. “Disqualified persons” generally are those who have an agency relationship with the taxpayer and may include the taxpayer’s employee, attorney, accountant, investment banker and real estate agent. Most identification notices are sent to a qualified intermediary.
The description of the Replacement Property must be unambiguous and specific. Generally, this means identifying the street address and/or legal description. A condo unit must have the specific unit number, and if the taxpayer is buying less than a 100% interest, the percentage interest being acquired should be noted.
If the Replacement Property is under construction at the time of identification, the IRS regulation account for this by requiring the identification to include the street address or legal description and as much detail as practical about the intended improvements.
In a reverse exchange, the taxpayer must identify in writing what he/she intends to sell as the Relinquished Property within 45 days from the date of the closing of the sale of the Replacement Property(ies).
The contents herein are intended to convey general information only and not to provide legal or tax advice. You are advised to contact your legal or tax advisor for specific advice on 1031 exchanges. No action should be taken in reliance on the information contained herein and we disclaim all liability in respect to actions taken or not taken based on any or all of the contents herein to the fullest extent permitted by law.