Do you know the 95% Rule for 1031 exchanges?

If you’re considering a 1031 exchange, then understanding the rules of the game is not an option – it is required. The IRS is very strict about applying the rules it has set forth that govern these amazing tax-deferral transactions. No surprise there. But what does catch investors off guard is the nuances of time deadlines for these transactions.

One of the most common pitfalls that I see in my work with clients on these type of real estate transactions? Missing the deadline to name possible replacement properties.

You may know that you have 45 days from the date you sell your relinquished property to identify possible replacement property. But did you know that you can name more than one? And if you name more than one, what rules surround that process?

One of the lesser-known and understood rules related to naming replacement property is the 95% rule. Basically, this rule lets an investor ignore the other rules for naming property (the Three-Property Rule and the 200% Rule) and name any number of potential replacement property of any value. Of course there is a caveat…

When it comes to closing on a replacement property (or properties), you must buy 95% of the aggregate value of the properties you name. So if you sold a property for $300,000, you could identify four properties worth a total of $2,000,000. But then you’d actually have to purchase at least $$1,900,000 (that’s 95%) worth of the named properties.

So while the 95% rule might initially sound like the answer to your prayers if you’re not sure what you plan to buy next, tread carefully or you could find yourself with a bigger purchase commitment than you intended. At least if you want to defer capital gains taxes with an IRS-approved 1031 exchange.

To find out how we can help you find and close on your next 1031 exchange property or to learn more about the exchange process and our qualified intermediary services, please visit our website.