Reviewing the 1031 Identification Rule

Section 1031 is an IRS code section that lets you defer tax (in some cases a LOT of tax). Of course, they don’t make the deferral easy, but it's not impossible, either.

One of the rules that causes a lot of angst, especially in a fast-moving real estate market like we have now, is the requirement that within 45 calendar days you must identify a list of properties you might want to buy. Whatever you buy to complete your exchange must be on this list. The identification is made on a form provided to you by your Qualified Intermediary (the 1031 specialist that the law requires you use to guide you through this process).

The identification period is calendar days (NOT business days), and begins on the date your sale closes. It includes weekends and holidays — which means if your 45th day falls on the 4th of July your identification must be received by your Intermediary by midnight of that date. Email is the customary method of transmitting your form to your Intermediary.

The rules allow you to identify three properties without limitation. If you identify more than three properties the IRS rules narrow and become tougher: if you identify four or more properties, the sum of the purchase price of ALL of the properties on your list cannot exceed twice the sales price of your old property. For example, if you sell your old property for $100,000 and list four potential replacement properties, the combined purchase price of ALL FOUR PROPERTIES cannot exceed $200,000. Had you only listed three properties, the combined purchase price of the three can total $20 million and beyond — because there’s no limit to the value of the replacement properties if your list is three or less.

The properties you list are properties that you might buy — you are not required to buy all of them — but you are required to buy at least one of them to complete your exchange. You can change the list as much as you want until midnight of the 45th day – at that point the door slams shut and the properties on your list are cast in stone.

...they don’t make the deferral easy, but it’s not impossible, either...

But what if a property you list is no longer available? A real possibility in a fast-moving market like we have now. The answer depends upon where you are in the 45-day limit. If you still have days left, you can remove the unavailable property and replace it with one that is. For example, if it’s day 30 of your 45-day period and one of your three listed properties just sold, you can remove that property from your list and replace it with another property. However, if you’re beyond the 45th day, your list is unchangeable and you only have two properties left to choose from to complete your exchange (assuming that you listed three properties to begin with). The 45 days are cast in stone.

So how do you deal with this in a fast-moving market? My best advice to our clients is to start as soon as you list your property for sale. As soon as the listing process is complete you should start looking for possible replacement property. Start looking for properties in your price range in your target neighborhoods. Figure out where you want to buy and what your options are within that area, then keep an eye on the area and get a sense for how long things stay on the market before they sell and what the true market prices are. Then as soon as your property goes under contract you want to get serious about making an offer.

Zero in on your choice property and get it under contract. Set the closing date for six weeks after the contracted closing date of your old property. Why six weeks? Because six weeks is halfway through the 45-day identification period — if you can close your purchase during those 45 days you don’t have to worry about making a list at all. Six weeks gives you some flexibility if the closing of the sale of your old property gets delayed. It also gives you time to find another property if something causes the closing your first choice to fall through.

Although the rules are restrictive, they’re not impossible if you have a good plan – and a good plan is critical in a fast-moving market like the one we have right now.

By Gary Gorman, founder, The 1031 Exchange Expert’s LLC

Gary Gorman is the founder and owner of 1031 Exchange Experts’ LLC, an independent national qualified intermediary. A retired CPA, Gary is the author of the best-selling 1031 exchange book: Exchanging Up!, and a contributor to numerous publications, including Forbes, The Wall Street Journal, Bloomberg’s and The New York Times. He’s also a contributing author of books by Donald Trump and Rich Dad/Poor Dad author Robert Kiyosaki. He can be reached at gary@expert1031.com, or nationwide, toll free at 866-694-0204.