Making a Section 1031 exchange is not always an easy endeavor; there are many rules, restrictions, and nuances that must be duly considered during the course of the exchange, and myriad potential complications that may arise. The good news, however, is that many of the risks involved in the 1031 process can be mitigated by way of a bit of foresight and planning. A part of the 1031 process that can be greatly simplified if the investor does his homework beforehand is the identification of a piece of replacement property.
By far the simplest approach to making an identification is to be sure {conduct the closing on your replacement property within the 45 day period after closing on the sale of your relinquished property. If you are able to purchase a replacement property within this period, you'll be considered to have identified the property by virtue of the fact that you have conducted the closing. In this way, you are able to absolve yourself of the obligation to make an identification on paper.
Missing this deadline means that you'll be obligated to submit your identification in writing, which will inevitably make the process much more complicated and labor-intensive. It would be impossible in the scope of this brief article to thoroughly cover all of the legal convolutions that can come into play in making a written identification, but here I will offer a quick overview of the two basic rules under which written identifications can work.
The first of these is the "Three-Property Rule," under which you you are allowed to identify properties of any value, but they cannot number more than 3 in total. While The "Three-Property Rule," is easy enough in concept, in reality it is often hard to figure out whether a replacement property constitutes one or several. As an example, if you were considering a property made up of several distinct parcels, you'd be forced 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 agreements. Your second option, the "Two-Hundred-Percent Rule," allows you to identify an unlimited number of replacement properties, but the values of the replacement properties you have identified cannot total up to greater than 200 percent of your relinquished property's value.
Whichever rule you decide to make your written identification under, it is necessary to be wary when submitting identifications on paper, as an incorrect identification is likely to result in an invalidated exchange. This hassle can, however, be mitigated, or indeed bypassed completely, with a bit of forethought. As an example, you could search for a suitable replacement property before even beginning the 1031, and, for added certainty, you can make a purchase agreement with the seller. In this manner, you can make absolutely certain that you'll be able to close on your replacement property within the forty-five day window, thereby avoiding the muss and fuss that comes with submitting your identification on paper. If, however, a circumstance arises in which you can see that you will not be able to close on your purchase within the 45-day window, do not hesitate to discuss any legal issues with a qualified expert, as a misstep may result in your exchange being deemed invalid.
