The Exchangor has a maximum of 180 days from the closing of the relinquished property or the due date of that year’s tax return, whichever occurs first, to acquire the replacement property. This is called the Acquisition Period. The first 45 days of that period is called the Identification Period. During this 45 days, the Exchangor must identify the candidate or target property which will be used for replacement. The identification must:
– Be in writing,
– Signed by the Exchangor, and,
– Received by the facilitator or other qualified party (faxed, postmarked or otherwise identifiably transmitted through Federal Express or other dated courier service).
This must all occur within the 45-day period. Failure to accomplish this identification will cause the exchange to fail.
Identification
Three rules exist for the correct identification of replacement properties.
1) The Three Property Rule dictates that the Exchangor may identify three properties of any value, one or more of which must be acquired within the 180-Day Acquisition Period.
2) The Two Hundred Percent Rule dictates that if four or more properties are identified, the aggregate market value of all properties may not exceed 200% of the value of the relinquished property.
3) The Ninety-five Percent Exception dictates that in the event the other rules do not apply, if the replacement properties acquired represent at least 95% of the aggregate value of properties identified, the exchange will still qualify.
As a caveat it should be mentioned that these identification rules are absolutely critical to any exchange. No deviation is possible and the Internal Revenue Service will grant no extensions.
* Ironically, although only approximately 3-5% of exchanges are audited, the few exchanges which don’t pass upon audit typically fail because of discrepancies in identification.
Mechanics of a Delayed Exchange
It is important that any exchange be carefully planned with the help of an experienced, competent and creative exchange professional. Preferably one who is completely familiar with the tax code in general, not just Section 1031, and who has extensive experience in doing many different kinds of exchanges. Thorough planning can help avoid many subtle exchanging pitfalls and also ensure that the Exchangor will accomplish the goals which the transaction is intended to facilitate.
Once the planning is complete, the exchange structure and timing are decided, and the relinquished property is sold and the transaction is closed, the facilitator becomes the repository for the proceeds of the sale. The money is kept in the facilitator’s secured account until the replacement property is located and instructions are received to fund the replacement property purchase.
The funds are wired or sent to the closing entity in the most appropriate and expeditious manner, and the replacement property is purchased and deeded directly to the Exchangor. All the necessary documentation to clearly memorialize the transaction as an exchange is provided by the facilitator, such as exchange agreement, assignment agreement and appropriate closing instructions.
Partnership Exchanges and IRC