When you search for “1031 exchange 45 day rule,” many of the articles that pop up are so complicated you’d be better off hiring a CPA to walk you through it.
Here at Custom Capital, we want to make things as easy as possible for you.
In this article, we’ll first explain what a 1031 exchange is and how it works before going into the 45-day rule in particular, along with a host of other “rules” that full under the 45-day umbrella, including: the three-property rule, the 200% rule, and the 95% rule. We’ll also cover what happens if you can’t find a replacement property by Day 45.
NOTICE: If you’re on day 40 of a 1031 exchange and struggling to identify a replacement property, schedule a call with us as soon as possible and explain your situation. We have dozens of high-quality, off-market NNN and NN properties but the IRS does not give any wiggle room if you miss the deadline (as you’ll read later on in this article).
What is the 1031 Exchange 45-Day Rule?
Once your relinquished property is sold, you have 45 days to identify any property that you believe is suitable as an exchange property under Section 1031 of the US Tax Code.
But let’s back up for a second. What is a 1031 exchange?
A 1031 exchange is a popular real estate investing strategy that lets you roll over the proceeds from a sold property into a “like-kind” property of equal or greater value. In doing so, you can theoretically defer capital gains tax indefinitely. If you want a full article on how the 1031 exchange works, just click here for our guide.
As you may have guessed, the 45-day rule is one of the most important things you need to know about the 1031 exchange. If you miss this deadline, that could result in the immediate failure of your 1031 exchange, leaving you exposed to a massive tax bill.
Treasury Regulation Guidance on 45-Day Rule
The overall gist of “26 CFR § 1.1031(k)-1 – Treatment of deferred exchanges” is as follows:
- The identification must be made in writing, signed by the exchanger, and delivered to the qualified intermediary, or other exchange party by midnight of the day that is 45 days after the date the relinquished property is transferred, regardless of weekends or holidays
- The property must be identified in a way that is clear and unambiguous.
- Any property acquired during the 45-day identification period will be deemed identified and will count toward the total number of properties ultimately identified in the 45-day period.
- If more than 3 properties shall be identified, there will be additional restrictions on the identification.
The Three Property Rule
This is one of the hardest aspects of the 45-day rule. You can’t just log on to Crexi or Loopnet, download a CSV of all of the properties in your buybox, click “Export,” and send it to the IRS. Instead, you need to identify up to three replacement properties (and if you want more, additional rules apply).
If you don’t acquire any of those three properties, you’ll technically “fail” to qualify for the 1031 exchange.
You may think that you’ve already identified the perfect property (particularly after meeting with one of our associates), but you should always utilize the remaining space. To put it even more simply: always have some back-ups, being careful to use the word “or” when identifying these properties instead of “and.” Since you can technically acquire multiple properties as part of your 1031 exchange, this relatively benign tip can save you a massive headache. If you identify three properties as part of a list, your 1031 exchange may not be complete until you purchase all three of those properties. You need to make it clear that you’re purchasing the $2.5M gas station OR the $3M medical clinic OR the $2.8M quick service coffee shop, etc.
But I’ve seen how quickly the team at Custom Capital sells properties. I’m afraid that you’ll sell the property that I want before I’m able to actually put an EMD down on it. 1) A reverse 1031 exchange is always an option, and 2) that’s where the 200% rule comes into play.
If you want to identify more than 3 properties, the IRS enforces some other rules…
The 200% Rule
Remember what we said above about how the IRS doesn’t want you to be able to log into Crexi or Loopnet, download all of the properties in your buybox, click export, and get a crazy long list of potential properties? The crux of the 45-day identification window is that they want to see that you’re seriously pursuing a commercial real estate property.
If you want to identify more than 3 properties, you can… but the combined market value of those properties needs to be less than 200% of the relinquished property.
Let’s say you’re selling a $8M multifamily building. You’re sick and tired of the maintenance and want to buy a net lease commercial building instead with a corporate guarantee from a solid tenant.
You see a $4M gas station that caught your eye, a $3M dentist’s office, a $2M industrial asset in the Midwest, another $2.5M gas station, and a $4M dialysis center.
Even though that’s five properties, you can identify all of them: 4 + 3 + 2 + 2.5 + 4 = 15.5.
$15.5M is less than double the value of the relinquished multifamily building ($8M x 200% = $16M).
The 95% Rule
You may also know this as “the portfolio rule.” It really only makes sense when you’re acquiring a portfolio of properties.
You can acquire any number of properties as long as you acquire 95% of the aggregate fair market value of those properties.
This makes the most sense if you’re selling a high-dollar-value commercial building and exchanging into a residential portfolio of 45 single-family homes. We don’t sell residential so it isn’t something that we see very often, although we’d highly recommend talking to Marissa LoCascio over at 1031Corp (who was on our recent webinar) if you have any questions.
What Happens if You Can’t Identify a Property Before the 45-Day Rule is Up?
Frankly, the IRS is unforgiving. If you can’t identify a replacement property in time, you cannot complete a 1031 exchange.
If you’re searching for this article before the 45-day deadline, we highly recommend that you hop on a call with us before the deadline expires. Here at Custom Capital, we have a team of 50 qualified full-time experts across seven divisions who are working tirelessly to identify high-quality commercial real estate properties for you.
And if you’re looking for a 1031 exchange expert, we highly recommend Marissa LoCascio over at 1031Corp. This is not an affiliate link, but as you could probably tell from our recent 1031 webinar, she’s absolutely one of the best in the business at the 1031 exchange.
