Three replacement properties

[Anthony Freeman]

Have you ever identified more than three replacement properties in a 1031 tax exchange?

[Dave Foster]

@Anthony Freeman, it's done quite frequently.  Usually in one of these circumstances.

1. When selling a larger asset and wanting to purchase several smaller assets.  The exchanger can name more than three replacements but the total value of the list will still be less than 200% of the net sale's price of the old property.

2. they are already under contract for their replacements so that they close on all of their replacements during the 45 day identification period.  Even though their list may breat the 200% rule they will close on all of their replacements during the 45 day period.  So they were able to purchase at least 95% of the value of their list.

Be very cautious about identifying more than 4 properties if their value is more than 200% of what you sold if you can't close on all of your properties during the 45 day period.  It only takes one property that you end up having to put on your iist but not close that will kill your exchange.

[Dave Foster]

@Anthony Freeman, it's done quite frequently.  Usually in one of these circumstances.

1. When selling a larger asset and wanting to purchase several smaller assets.  The exchanger can name more than three replacements but the total value of the list will still be less than 200% of the net sale's price of the old property.

2. they are already under contract for their replacements so that they close on all of their replacements during the 45 day identification period.  Even though their list may breat the 200% rule they will close on all of their replacements during the 45 day period.  So they were able to purchase at least 95% of the value of their list.

Be very cautious about identifying more than 4 properties if their value is more than 200% of what you sold if you can't close on all of your properties during the 45 day period.  It only takes one property that you end up having to put on your iist but not close that will kill your exchange.

[Eric Fernwood]

Hello @Anthony Freeman,

We have completed over eighty 1031 exchanges to date, and our largest number of replacement properties in one exchange was five. It was a bit of a scramble, but it worked. In this post, I will discuss some potential pitfalls that can result in you losing your tax deferment.

Before I continue…

The exchange process is illustrated below:

The 45-Day Identification Period

The 45-day replacement property identification period starts when the relinquished property closes. Identifying the replacement properties is the first potential pitfall.

Although you are only required to identify replacement properties during the 45-day window, you may lose your tax deferment if you are unable to or choose not to close on them. This could occur if you are outbid or if a serious issue is identified during the due diligence process, making it not worthwhile to complete the purchase.

Our Process

Our goal is to put replacement properties under contract immediately after all contingencies are complete on the relinquished property. We then aim to close on the replacement properties as soon as possible after the relinquished property closes. Typically, cash purchases close about two weeks after the relinquished property, while financed purchases close four weeks later. The steps are illustrated below.

By utilizing this method, if something does not pan out with one or more of the replacement properties, we still have ample time to locate, put under contract, and validate (due diligence) another property within the 45-day identification period.

Movement of Funds

A regular question I receive is if a 1031 exchange agent is required. The simple answer is yes. If the funds touch your accounts, you lose your tax deferment.

Below is an illustration of the flow of funds during a 1031 exchange. The funds must move from the closing escrow agent to the 1031 exchange agent. When you close on the replacement property, the funds go from the 1031 exchange agent to the escrow company handling the closing. The funds must never be in your hands, or the 1031 exchange may be void.

Other Potential Pitfalls

• You are not allowed to use the proceeds from the relinquished property to pay for renovations. Some of our clients have opted to pay capital gains tax on a portion of the proceeds and use that money for the renovation.
• Not all purchase contracts include the 1031 exchange language. Make sure to have your listing agent obtain the correct language from your exchange agent for your state. The agent should include it in the agent-to-agent remarks, specifying that the 1031 text must be included in offers. If this does not happen, you can counteroffer specifying the required 1031 language.
• To fully defer the capital gains tax, you must reinvest all the proceeds from the sale into the replacement property. Any cash or other non-like-kind property received during the exchange will be subject to capital gains tax.
• To accurately determine the cost of the replacement property for tax purposes, it is important not to make any assumptions. Instead, obtain the required replacement cost from a 1031 exchange agent. We once had a client who assumed that their replacement property had to cost $300,000 or more, only to discover through the exchange agent that they actually had to spend over $500,000. There is no room for error in this process, so it is crucial to work closely with an exchange agent. If anyone would like a referral to a good 1031 exchange agent, DM me. We can provide you with the contact information for three exchange agents who are known for being easy to work with and highly knowledgeable.
• If there is an existing mortgage debt on the relinquished property, it's important to consider how it will be handled during the exchange. Any reduction in debt or cash received may be treated as taxable boot, resulting in potential tax liabilities. Do not assume, ask your 1031 exchange agent.
• Qualified Use Requirement - Both the relinquished and replacement properties must meet the requirement of being held for investment or used in a trade or business. Personal residences or properties primarily held for personal use do not qualify for a 1031 exchange.
• State Tax Considerations - While 1031 exchange tax deferments are allowed under federal tax law, not all states conform to these rules. It's crucial to understand the state-specific regulations regarding like-kind exchanges, as some states may not recognize or fully conform to the federal provisions. Consult with a tax professional familiar with your state's laws.
• The Biden Administration's proposed FY 2024 budget includes the creation of “capped deferral” for 1031 exchanges. In this proposed change to 1031 exchange laws, taxpayers in FY2024 would only be able to defer capital gains up to an aggregated amount of $500,000 for each taxpayer ($1 million for joint filers). Source. If you are considering a 1031 Exchange, 2023 may be the last year to do it.

Hope this helps,

…Eric

[Anthony Freeman]

Quote from @Eric Fernwood:

Hello @Anthony Freeman,

We have completed over eighty 1031 exchanges to date, and our largest number of replacement properties in one exchange was five. It was a bit of a scramble, but it worked. In this post, I will discuss some potential pitfalls that can result in you losing your tax deferment.

Before I continue…

The exchange process is illustrated below:

The 45-Day Identification Period

The 45-day replacement property identification period starts when the relinquished property closes. Identifying the replacement properties is the first potential pitfall.

Although you are only required to identify replacement properties during the 45-day window, you may lose your tax deferment if you are unable to or choose not to close on them. This could occur if you are outbid or if a serious issue is identified during the due diligence process, making it not worthwhile to complete the purchase.

Our Process

Our goal is to put replacement properties under contract immediately after all contingencies are complete on the relinquished property. We then aim to close on the replacement properties as soon as possible after the relinquished property closes. Typically, cash purchases close about two weeks after the relinquished property, while financed purchases close four weeks later. The steps are illustrated below.

By utilizing this method, if something does not pan out with one or more of the replacement properties, we still have ample time to locate, put under contract, and validate (due diligence) another property within the 45-day identification period.

Movement of Funds

A regular question I receive is if a 1031 exchange agent is required. The simple answer is yes. If the funds touch your accounts, you lose your tax deferment.

Below is an illustration of the flow of funds during a 1031 exchange. The funds must move from the closing escrow agent to the 1031 exchange agent. When you close on the replacement property, the funds go from the 1031 exchange agent to the escrow company handling the closing. The funds must never be in your hands, or the 1031 exchange may be void.

Other Potential Pitfalls

• You are not allowed to use the proceeds from the relinquished property to pay for renovations. Some of our clients have opted to pay capital gains tax on a portion of the proceeds and use that money for the renovation.
• Not all purchase contracts include the 1031 exchange language. Make sure to have your listing agent obtain the correct language from your exchange agent for your state. The agent should include it in the agent-to-agent remarks, specifying that the 1031 text must be included in offers. If this does not happen, you can counteroffer specifying the required 1031 language.
• To fully defer the capital gains tax, you must reinvest all the proceeds from the sale into the replacement property. Any cash or other non-like-kind property received during the exchange will be subject to capital gains tax.
• To accurately determine the cost of the replacement property for tax purposes, it is important not to make any assumptions. Instead, obtain the required replacement cost from a 1031 exchange agent. We once had a client who assumed that their replacement property had to cost $300,000 or more, only to discover through the exchange agent that they actually had to spend over $500,000. There is no room for error in this process, so it is crucial to work closely with an exchange agent. If anyone would like a referral to a good 1031 exchange agent, DM me. We can provide you with the contact information for three exchange agents who are known for being easy to work with and highly knowledgeable.
• If there is an existing mortgage debt on the relinquished property, it's important to consider how it will be handled during the exchange. Any reduction in debt or cash received may be treated as taxable boot, resulting in potential tax liabilities. Do not assume, ask your 1031 exchange agent.
• Qualified Use Requirement - Both the relinquished and replacement properties must meet the requirement of being held for investment or used in a trade or business. Personal residences or properties primarily held for personal use do not qualify for a 1031 exchange.
• State Tax Considerations - While 1031 exchange tax deferments are allowed under federal tax law, not all states conform to these rules. It's crucial to understand the state-specific regulations regarding like-kind exchanges, as some states may not recognize or fully conform to the federal provisions. Consult with a tax professional familiar with your state's laws.
• The Biden Administration's proposed FY 2024 budget includes the creation of “capped deferral” for 1031 exchanges. In this proposed change to 1031 exchange laws, taxpayers in FY2024 would only be able to defer capital gains up to an aggregated amount of $500,000 for each taxpayer ($1 million for joint filers). Source. If you are considering a 1031 Exchange, 2023 may be the last year to do it.

Hope this helps,

…Eric

 Very helpful especially the added information about possible changes in the tax code thank you.

[Jyothi Jagannathan]

Hi Eric- thank you for this very useful info. I am also in search of 1031 intermediary. Can you please DM me your recommendation- thanks, Jyothi

[Natalie Bender]

@Jyothi Jagannathan I am in the DST space and work very closely with Qualified Intermediaries. My go to is Weiming Peng with Excel1031. He is extremely knowledgeable and has been in the 1031 business for 10+ years. I haven't ran into a scenario he hasn't see yet. Definitely worth a call.

www.Excel1031.com