Category Archives: Property Identification

Challenges and Fixes to Identifying 1031 Replacement Properties…on 10/31

Challenges

Yesterday we looked at how to identify replacement 1031 properties as a continuance of my recent conversations with Michael on Rain City Guide from Team Reba. Today we look at identification difficulties. It’s only proper that our discussion of potential spooks and spills in 1031 exchanges comes on 10/31, the scariest day of the year! Hopefully you won’t be scared of helping clients and yourself identify replacement properties after this.

Over time our firm has observed three primary challenges to identifying properties within the allotted 45-day time period:

  1. Finding something of value in a changing market
  2. Obtaining the desired property before others do
  3. Finding property that would “pencil out” into a profit


 


 

 

To fix potential identification problems these four actions can help an exchanger

  1. Plan and Prepare by looking down the road to the property types you are interested in and their location. Once that is determined with your Realtor, you can start working with a Qualified Intermediary to plot out the steps necessary to see fruition of your goals.
  2. Seek to use all of the time available. You should always seek to maximize the time available to search for property. From a practical matter it isn’t too hard to double or quadruple the time and have three to six months available. No one can really change the 45-day identification period, but it can be extended by searching for replacement properties before you sell and even before you list the relinquished property. Talk to me and we can get some specifics hammered out for your situation.
  3. Tie up at least one of the properties identified by the 45th day in order to assure that you can get at least some bang for your buck. This would include signing a Purchase and Sale Agreement and putting down some earnest money.
  4. Consider a Reverse Exchange
    if necessary. What is a reverse exchange? It is an exchange where the new purchase is closed before the sale of the old property. It is useful in today’s real estate market because sellers are not willing to accept contingent offers and exchangers need more time to find suitable replacement property. We are doing 10 times the number of reverse exchanges today that we were doing a few short years ago.

    Why does it buy time? The IRS clock doesn’t start ticking until you buy replacement property, therefore you can spend all the time you want looking for it. Then the relinquished property can be put up for sale and you have 180 days to find a buyer and close on the sale.

Hopefully these tips can help you and your clients not fall prey to the ghostly pitfalls of the spooky 1031 Identification rules on this 10/31. Now go out and have fun trick or treating with your kids and be safe! A great 10/31 to you from The 1031 Like-Kind Exchange Blog!

2 Comments

Filed under 1031 reverse exchanges, Property Identification

Identifying your Replacement 1031 Properties

Over the last week or so I have been having a running dialogue with Michael Lindekugel of Team Reba – RE/MAX Metro Realty, Inc. about general 1031 exchange principles on the Rain City Guide. To continue that conversation about identifying replacement 1031 properties, I decided to post here about how to identify replacement properties. Tomorrow I will talk more about the challenges to identifying 1031 replacement properties and some ways to fix the potential identification problems. Sorry to Eileen Tefft for being a little late on the post.

The Identification Rules

When doing a 1031 exchange one of the greatest challenges we have seen is our clients do not often understand how to properly identify appropriate properties within the 45-day time deadline.

No matter which of the three identification rules is followed, the properties must be identified and submitted to the client’s Qualified Intermediary before midnight on the 45th day after the closing date of the first sold property.

Three Property Rule – The norm

The first identification rule is to identify three (3) properties of any value within the 45-day time period. The bulk of exchangers will follow this first rule.

200% Rule – Used sparingly

Michael stated the second rule well in our earlier conversations:

The exchanger identifies any number of properties as long as the aggregate FMV is less than or equal to 200% of the aggregate fair market value of all disposed properties.”

For example, if I sold $500k worth of properties, I could identify an infinite amount of properties so long as their aggregate FMV did not exceed $1 million (200% of the aggregate relinquished FMV). This rule is used sparingly as most people keep their options to less than three properties as they have a goal in mind of where they want to be and how much they want to spend. This second rule is useful though for especially hot markets where a property you identified has the potential to be sold before you can purchase it.

95% Rule – Used very rarely

The third rule states that an exchanger can identify as many properties as they wish for whatever aggregate value, so long as they close on 95% of the properties they identified. This does not mean that you purchase 95% worth of the aggregate FMV that was identified, it means that you must close on every 19 of 20 houses you identify. It’s a very stringent rule that seems unrealistic, but some people – especially big-time investors – will be exchanging this many properties at once. The more realistic application of this rule exists in the example below.

Suppose you want to identify and purchase 5 properties but their aggregate FMV is over 200% of the sold properties’ FMV. This would vitiate the 3 Property Rule and the 200% Rule. So, if you are certain you will close on all 5 then you will want to follow this rule as closing on all 5 means that you will close on 100% of your identified properties.

But what if you only close on 4 of the properties? That means you have purchased only 80% of your properties, and because you used the 95% Rule for identifying your properties, your whole exchange is null and void. Taxes will be due and the government looks at it as if no exchange took place.

This rule is very cumbersome and generally only used by large investors who have great trust that they will be able to get nearly all of their properties. But, it can be used on a smaller scale too, as evidenced in our example.

Now that we know the rules, tomorrow we’ll discuss the challenges that identification of replacement properties brings and how to fix these challenges before they actually become challenges.

4 Comments

Filed under 1031 exchange basics, Property Identification