1031 Exchange Panic, looking for quick help

11 Replies

We want to identify 8 properties. 

1. If one property falls through is the whole exchange lost or just the one property's value gets subtracted from total value of property accumulated and liable for capital gains tax?

2.  If one property fails to close escrow, can I apply what would qualify as down payment to another property with an open escrow?

3. With the 200% rule, can I identify more properties, than I ultimately buy or once identified do I have to buy all identified properties.

Search extensively on line, all information vague.  Read BiggerPockets Brandon blog, doesn't address issue.  ]

Thanks for assistance

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1 and 2. You do not need to close on all the properties you identify so if a property falls through, no harm no foul. As long as you This is only sort of true if you are using the 95% rule to identify greater than 3 properties tbough. If you are using the 95% rule then you must purchase 95% of what you have identified. So if one property fails to close you can complete the purchase on any other property. As long as you are trading up in value and use all your exchange proceeds on replacement property you will not be taxed. So if you identified 8 properties (using the 200% rule) and you only close on 5 but those 5 are greater than the Relinquished Property in value then you will not be taxed even if those 3 fall throihh. Nothing to truly panic about, but each scenario must be looked it to see if you qualified for the 200% rule (more on this below)or you must follow the 95% rule which is much more difficult to adhere to. 

3.The 200% rule allows you to identify as many properties as you would like, as long as the fair market value is not more than 200% of the fair market value of your relinquished property. You do not have to close on any amount of properties, you just need to close on more than 100% of the value of the Relinquished Property to ensure you defer all your tax. 

@Sharon Whipkey , You can relax.  There's a lot of outs for you.  First of all there is no penalty for starting but not completing a 1031 exchange.  If you can't find good properties or if your properties all fall through then you let your exchange die and it's like it never happened.  The worst case is you pay tax on profit.  And no one ever went broke paying tax.  It just doesn't feel good!!!  So....

1. Use the 45 days and the days leading up to your sale) to get as far as you can in your replacement search. It's not uncommon at all for a client to have their new properties under contract even before their old property closes.  And of course you still have all of the 45 to keep looking.  If you're still within the 45 days you just find/name other properties.  

2. If you're past your 45 days you're stuck with the properties that are on your list.  But you don't have to close them all.  Remember that in order to defer all tax you must purchase at least as much as you sell and use all of the proceeds from the sale in your purchases.  

But you can purchase less than you sell and you can take cash out but you'll pay tax on the difference.  So it does depend on the numbers but if you wanted to close on 4 and only closed on three it's very possible that you would not have a taxable event - as long as the three you closed on were equal to or greater than the property you sold.  If the cumulative total was less, then you would pay tax only on the difference without impacting the rest of your exchange.

And you can use the proceeds in any fashion you want.  So if one property falls through you can apply extra cash to another.  

3. Your 45 day list is only a list of your potential replacements.  It does not dictate how many you purchase - only how many you identify as potentials.  It is very common to use the list to include a back up or two.  The nature of the 200% rule if you're actually wanting to name 8 potential replacement properties does limit you somewhat because you can't go over 200% of the value of what you sold.  But there is one more exception to that 200% rule (even though it's a tough one to meet) and that is that you can break the 200% rule as long as you purchase 95% of the value of the list.  Again, that's probably not one you want to rely on.  But it's a possibility.  

4. Back up properties and things like DSTs or TICs can be great comfort as back ups as well.  Again tougher to make work with the 200% rule and wanting to name 8 potentials but still an option.  

The 200% rule works good for selling an asset and buying several smaller assets.  But in your case it may be tough to keep 8 potentials under that limit.  So here's a couple options.

-Shop fast and get contracts and actually close on all the properties you want during the 45 day period.

-drop any iffy property off your list by day 45 so if needed you have a good chance of closing 95% of the value.

- purchase fewer replacements and concentrate the cash on very few.  Just close enough to cover your reinvestment target.  Then after the exchange is complete you can refinance the property/properties that you put a lot of cash down on and use the refi proceeds to purchase more properties without being hindered by the 1031 clock.

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Thanks to all of you for your thoughtful and helpful answers.  We were able to successfully close on 5 properties prior to the 45 days, 2 properties a couple days after the 45 days and the last two are in underwriting now.  It's been quite the education.  We knew our property would be listed between June to August 2019.  Our house listed in August sold after two weekends, with a 14 day escrow.  

We began studing the 1031 process in about February, finding the information confusing and mind boggling.  Calculators designed to assist in determing the capital gains taxes vs 1031 Exchange process are opaque at best, with most of the calculations hidden in the background formulas. I know somewhere in the universe is a 1031 Exhange for Dummies, I couldn't find it though.  No matter, knowing how short 45 days is to identify property, we began looking for replacement properties in March 2019. We made a trips in state and to the out of state markets that looked interesting.  We attempted to get all our identified properties in contract and closed by the end of the 45 days.  In one of the markets we chose, every general inspection turned up too many major issues for us.  When the last property, we just knew would sail through inspections and didn't, is when I began to panic.  I tried for months to get a straight answer regarding the difference between property identification period vs the remaining 135 days to close on identified properties without success. Which is why we attempted to get every property we wanted under contract prior to the end of the 45 days. Thank goodness one of the turnkey companies we work with came up with about 3 properties we could identfy, plus we picked a couple from our troublesome market. 

I'm sure others experience the same whirwind of paper work created when attempting to indentify, get under contract, inspect, counter offer, and close on 7 to 9 properties in 45 days.  To say we were slightly overwhelmed is putting mildly. As we approach the end of this phase of our adventure we are relieved to successfully managed the 1031 Exchange process.

I would be happy to help anyone going through a 1031 from a lay person's perspective.

@Sharon Whipkey , It doesn't have to be that hard to understand!  But the time frame limitations will always be there.  Congratulations on a successful navigation.  And I do love the title but if you're doing a 1031 - you're no dummy :)

@Sharon Whipkey Probably helpful to understand what "identification" is about and its implications within a 1031.

The IRS has decided that any property not properly "identified" is treated as NON-like kind to the property that you are replacing. The IRS then imposed limitations on what's considered properly identified.

  • Identify up to 3 properties, regardless of value.
  • Identify unlimited number of properties, provided that their aggregate FMV - determined as of the end of the "identification period" - does not exceed 200% of the relinquished property (as of the date it was relinquished).
  • If the 3-property and 200% rule are violated, property will still be treated as properly identified, and therefore of "like-kind" if:
    • The property was actually bought within the 45-day identification period, or
    • If identified property with FMV of 95% of all identified properties are actually bought within the exchange period.

To answer your questions:

1. If one of your identified properties does not close, the only implication is that you have fewer identified properties to which to apply your exchange proceeds. If you can still avoid trading down in value or equity, no tax.

2. Yes

3. You can identify more than you actually close on.

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