By: Whitney Nash, Qualified Intermediary & Owner, Above & Below 1031, LLC and CCAR Affiliate Committee Member
Investing in real estate can be a powerful way to build wealth, and savvy investors often leverage strategies to maximize their returns while minimizing tax burdens. One such strategy is the 1031 exchange, a section in the U.S. Internal Revenue Code that allows investors to defer capital gains taxes and depreciation recapture when they sell a property and reinvest the proceeds in like-kind real property. However, this tax-deferral strategy comes with strict rules and timelines, particularly the 45-day and 180-day deadlines, as well as specific identification (ID) requirements. Let’s break these down with some examples to understand how they work when completing a forward 1031 exchange.
The 45-Day Deadline: Identifying Replacement Property
The 45-day deadline is the first critical deadline in a 1031 exchange. From the date the exchanger closes on the sale of their relinquished property, they have exactly 45 calendar days to identify potential replacement properties. This identification must provide specific addresses, be in writing, signed and dated by the exchanger, and delivered to the qualified intermediary facilitating their exchange by midnight of the 45th day.
When making the identification, the exchanger can choose from one of three rules:
- The Three-Property Rule: The exchanger can identify up to three properties, regardless of their market value, and purchase any number of them, or
- The 200% Rule: The exchanger can identify four or more properties as long as their total fair market value doesn’t exceed 200% of the value of the relinquished property, and purchase any number of them, or
- The 95% Rule: The exchanger can identify four or more properties, regardless of value, as long as they acquire at least 95% of the total value identified.
Example of Each Identification Rule: Let’s say the exchanger sold a property worth $500,000. Under the three-property rule, they could identify three potential replacements, no matter their value. Using the 200% rule, they could identify five properties worth up to a combined $1,000,000. Or, if they chose the 95% rule, they might identify ten properties but would need to acquire at least 95% of their combined value.
The 180-Day Deadline: Completing the Exchange
Once the exchanger has identified potential replacement properties, they must complete the purchase(s) within 180 days from the date they sold their (first) relinquished property. It’s important to understand that this period runs concurrently with the 45-day identification period — they don’t get an additional 180 days after the first 45 days are up.
Example Deadlines: If the exchanger sells their property on May 1st, their 45-day deadline is June 15th and their 180-day deadline is October 28th. They must close on one or more of the identified properties by October 28th to qualify for the tax deferral. Any unused funds would be subject to taxation.
Important Caveats
- If either date lands on a weekend or holiday, that’s the date. There are no extensions.
- If changes to the ID letter are needed within the 45-day window, they can amend it. If they are past the 45th day, they are locked in. The exchanger cannot make changes to or purchase replacement property that is not on the ID letter. They cannot submit a backup letter.
- If the exchanger is using the 200% or 95% rule, they need to keep documentation that proves the value of each property at the time of identification just in case they are audited in the future.
Why These Rules Matter
Failing to meet either deadline or properly identify replacement properties can disqualify the exchange, leading to immediate taxation of capital gains. Many exchangers work closely with their real estate professional and qualified intermediary to ensure they stay compliant.
By understanding and carefully adhering to the 45-day and 180-day rules, and choosing an appropriate identification strategy, the exchanger can make the most of a 1031 exchange and keep their real estate investments growing tax-deferred for years to come.