Real Estate Investors: Three Ways To Identify A 1031 Replacement Property

Conducting a Section 1031 exchange is not always an easy endeavor; there are many factors that must be taken into consideration during the course of the exchange, and myriad potential complications that may crop up. The good news, however, is that many of the contingencies involved in the 1031 process can be mitigated by way of a bit of preparation and forethought. One part of the 1031 process that can be greatly simplified provided that the investor does his homework beforehand is the identification of a suitable replacement property.

By far the simplest way to make a identification is to be certain {conduct the closing on your chosen replacement property within the forty-five day period after conducting closing on your relinquished property's sale. If you manage to conduct your closing during this period, you'll be seen as having identified the property by virtue of closing on its purchase. In this manner, you are able to free yourself from the obligation to make your identification in writing.

Missing this deadline means you'll be obligated to submit your identification in writing, which will inevitably make the undertaking much more complicated and work-intensive. It would be impossible within the confines of this brief overview to thoroughly cover all of the legal minutiae that you may have to consider in the course of making a written identification, but I will now offer a quick overview of the two essential ways in which these identifications can work.

The first of these is the 3-property Rule, which indicates you can identify pieces of property regardless of value, but they must not be more than 3 in number. While The 3-property Rule, is easy enough in concept, in reality it is often hard to figure out whether a replacement property comprises one or several discrete pieces of real estate. As an example, if you were considering a piece of property made up of three or four parcels, you'd have to take into consideration factors such as the location of the parcels, and whether they are being sold under 1 purchase agreement or several separate ones. The second option, the Two Hundred Percent Rule, lets you choose an unlimited number of replacement properties, but the values of the replacement properties you have identified can't total up to greater than 200 percent of the value of your relinquished property.

Whichever rule you decide to make your written identification under, it is important to be cautious when submitting identifications on paper, as the result of an incorrect identification is an invalidated exchange. This risk can, however, be mitigated, or even avoided completely, with a modicum of forethought. As an example, you can search for a suitable replacement property in anticipation of a 1031 exchange, and, for additional surety, you can draw up a purchase agreement with the seller. In this manner, you can make absolutely certain that you'll ultimately be able to purchase your chosen replacement property within the 45-day time frame, thereby avoiding the muss and fuss that results from missing this deadline. If, however, a circumstance arises in which you can see that it will be impossible to close on your purchase within the 45-day time frame, do not hesitate to discuss any legal issues or doubts with tax adviser or other legal expert, as a misstep may result in the invalidation of your exchange.

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