Bifurcating Closings Can Add Flexibility to Your 1031 Exchange

"bi‚fur‚cate: verb, meaning to divide into two parts." "Bifurcate" in real estate terms means to divide into two closings. Bifurcating your closing can result in some serious 1031 benefits for you. In the correct situation it can really supercharge your exchange.

Let's take a hypothetical situation and let me show you how this works: Let's say that you are selling a large piece of land for $10 million. This land is composed of two parcels: one 20 acre and one 30 acre for a total of 50 acres.One of the requirements for a 1031 exchange is that within 45 days you have to identify a list of properties you might buy. If your list has three properties or less, there are no limitations. However, if your list exceeds three properties, you are subject to the "200 Percent Rule" of Section 1031, which requires that the combined total purchase price of everything on your list can not exceed twice the selling price of the Old Property.

...In the correct situation, Bifurcating can really supercharge your exchange...

In other words, if you only place three properties on your list, and the purchase price of each property is $25 million, you're okay. But if you put four or more properties on the list, the total combined price of all the properties can not exceed $20 million (i.e. $10 million x 2).

One problem you have in this robust market is it can be tough to find three properties that meet your criteria and can survive your due diligence. Another problem is that $10 million is a big chunk to reinvest, and you may have to settle for several smaller properties in order to meet the $10 million "equal-or-up" target imposed by Section 1031. Wow! A hot real estate market where properties move fast; value vs. pricing challenges; and reinvesting to satisfy a larger equal-or-up requirement -- these are difficult issues! So, how do we tackle these problems?

This is where bifurcating the closing can work to your advantage. Let's say you split the contract into two different closings: $4 million for the 20 acre parcel and $6 million for the 30 acre parcel. The two separate closings create two separate exchanges, which gives you three unlimited identifications for each closing, for a total of SIX. This also means you are working with two smaller exchanges which can make finding replacement property easier.

So what happens if you find two replacement properties "A" and "B," each for, say, $5 million? This is not a problem for the 'little' sale, because your equal-or-up target ($4 million) is less than the purchase price of either of the two New Properties. But the 'bigger' sale ($6 million) is a problem because to avoid paying tax you need to exceed the purchase price of either $5 million lot.

The solution is to identify "Property A" for $5 million, IN ADDITION TO 20% OF "PROPERTY B," as your replacement for the $6 million property so you can defer all the tax. Then identify 80% of "Property B" to replace the $4 million property.

...This also means you are working with two smaller exchanges which can make finding replacement property easier...

How does the IRS view bifurcating your sale? There are indeed cases disallowing an exchange where they decide that bifurcation is being used to accomplish the things I've talked about above. The best way to avoid this is to have separate contracts for each lot. Secondly, try and have the closings on two different days. And thirdly, see if the buyer of one part of your sale is willing to purchase the other part of your sale as a different entity, like an LLC. How? In most cases the same buyer will buy both properties, but if the buyer is accommodating, you might be able to get him to set up a single member LLC to take title to one of the properties.

Choosing an experienced Qualified Intermediary for this strategy is essential.