Timing Rules Do Matter In 1031 Exchanges

For investors who want to defer capital gains tax on the sale of business or investment property, a 1031 exchange can be a very good choice. However, before entering into this type of transaction, you must fully understand the IRS time restrictions that apply.

45-Day Rule for Identification.

This rule requires that the investor either close on the purchase of the replacement property or identify potential replacement property within 45 days of transferring the relinquished property. The IRS insists on strict adherence to this time limit or else the 1031 exchange will fail. To comply, an investor must, within the 45 days, close the sale or comply with one of the following:

Three-Property Rule – Up to three alternate properties may be identified, regardless of their market values.

200% Rule – Any number of replacement properties may be identified, so long as the aggregate fair market value of the replacement properties does not exceed 200% of the aggregate fair market value of the exchanged properties on the initial transfer date.

95% Rule – Any number of replacement properties so long as the fair market value of the properties actually received by the end of the exchange period is at least 95% of the aggregate fair market value of all the potential replacement properties identified.

180-Day Rule for Receipt of Replacement Property.

This rule works in conjunction with the 45-Day Rule for Identification, and governs any deferred 1031 exchange. Confusion sometimes arises with the 180-Day Rule, due to the either/or nature of the requirement. To comply with the rule, an investor must receive replacement property and complete the exchange no later than the earlier of:

1. 180 days after the transfer of the relinquished property, OR
2. The due date of the income tax return, including extensions, for the tax year in which the relinquished property was transferred.

With regard to the second provision, it is important to note that failure to put an extension on a tax return may shorten the 180 days if the relinquished property was transferred near to April 15th. This often catches unwary investors off-guard. It is important to file an extension to the tax return if an exchange is started close to April 15th.

There are a few other things to note about the 180-Day Rule.

Any replacement property must be substantially the same as the property that was identified under the 45-Day Rule. Also, there is no provision for extension of the 180 days, either due to hardship or any other circumstances with one exception. The 180 days can be extended for areas declared disaster areas by the president.

Failing to comply with any of these rules will put your exchange at risk of rejection by the IRS. At that point, capital gains taxes would be due.

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.