Forty-five days: that’s the simple answer. But that’s not all there is to a 1031 exchange. Well, if you’ve invested in a property and are considering letting it go, you’ve probably chanced upon the 1031 exchange. In case you’ve not, today’s your lucky day! The investment field is replete with terminology that sometimes can get confusing. We need to get the basics out of the way first.
Generally, a 1031 exchange lets you off the hook when you need to sell your investment property, allowing you to defer payment of capital gains tax. However, you need to reinvest your proceeds within a given timeline in a like-kind or similar property of equal or more value.
Specific 1031 exchange timelines and rules come into play, and understanding them as an investor can go a long way towards validating your exchange. I know what you’re thinking. You’re probably wondering about the rationale for identifying a property in the first place.
As noted from the get-go, you have up to 45 days to identify properties or a replacement. Upon identification, you have 180 days- although this can be shorter depending on prevailing circumstances- to buy either one of the properties you’ve identified. Also, you do not have to specifically identify property if you acquire it within the identification period.
Plus, the 180-day window to complete an exchange includes the 45-day identification period. So, it’s not 180 plus 45 days. The clock starts ticking the day you relinquish the original property.
The 45/180-day timeline creates a limitation and a compromise of sorts by allowing you some time after selling a property to acquire a new one. In short, it provides a reprieve, so you don’t have to purchase(exchange) a new property to replace the one you’ve sold. I hope you get the drift.
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Grasping the rules for identification is an essential first step to ensuring your re-investment is eligible for tax deferment. Here’s a brief overview of some of the rules governing a 1031 exchange.
The 45-day window marks the identification period commencing when you transfer property and lapses at midnight 45 days after that. What are the pre-requisites for a valid identification? Here’s a list of requirements:
However, you cannot notify a disqualified person of your intention to acquire a property. Disqualification, in this case, implies anyone likely to offer you an undue advantage due to your association with them. Such persons could be your employees, investment broker, or attorney- generally anyone with whom you share a close relationship.
You are also entitled to revoke an identification during the 45 days. Provided you replace the identification with a new one within the window period, you are within the bounds of the rule.
Under this rule, you are at liberty to identify three properties at most, regardless of their market values. It would be best if you also had the intention in mind to acquire one or all of the properties identified.
A walk down memory lane shows that 1031 exchanges might have had a ‘checkered past.’ Formerly, priority was often placed on an identified property. You could only replace the identified property if the initial deal to acquire it fell through. It sounds harsh and may have been instrumental in reshaping the present 1031 three-property rule.
The long and short of this rule is that it opens the door for you to identify more properties than authorized by the 3-property rule. Generally, you are free to find additional properties, provided their total value falls below 200 percent of the going rate (fair market value) of your original property- the one you’ve relinquished.
Identifying more than three properties can help you create a ‘cushion.’ If the value of either one of the identified properties exceeds the initial estimate, you would still have a fallback plan in the form of the remaining properties.
If you opt to identify an unlimited number of properties whose aggregate market value goes beyond 200% of the original property, you’re required to acquire 95% of the identified properties’ value. An example should suffice to drive the point home.
Let’s assume you’ve identified five properties with a market value higher than 200% of the property you sold. Your identification is valid if the value of properties you close on delivers at least 95% of the fair market value of identified properties.
Now that you’re up to speed on matters relating to 1031 exchange timelines and rules, I hope you can stay in Uncle Sam’s good books. Stick to these rules, and the investment field will continue to be your playground.