1031 Exchange: What Is The 45-Day Rule?

Not every 1031 exchange involves property that is simultaneously relinquished and replaced. In fact, in a majority of exchanges an investor knows he or she wants to sell an existing property but has not yet found a suitable, like-kind replacement property. In these cases, a 1031 exchange can still be successfully completed so long as several time requirements are met.

One of these requirements is the 45-Day Rule for Identification.

This rule requires that the investor either close on the purchase of the replacement property or identify potential replacement property within 45 days of transferring the relinquished property. The IRS insists on strict adherence to this time limit or else the 1031 exchange will fail.

So how does an investor comply with this rule? The easy way is by closing on the like-kind replacement property within 45 days. However, when that is not possible the investor can alternatively provide to the qualified intermediary a written document called the Identification Notice within this 45-day period. This written notice must include an unambiguous description of the replacement property, including the legal description, street address or distinguishable name.

It is a good idea for an investor to identify more than one replacement property to hedge against a failed transaction that would cause the failure of the entire 1031 exchange. However, it is important to understand additional limitations imposed by the IRS when it comes to replacement property:

Three-Property Rule – Up to three alternate properties may be identified, regardless of their market values.

200% Rule – Any number of replacement properties may be identified, so long as the aggregate fair market value of the replacement properties does not exceed 200% of the aggregate fair market value of the exchanged properties on the initial transfer date.

95% Rule – Any number of replacement properties so long as the fair market value of the properties actually received by the end of the exchange period is at least 95% of the aggregate fair market value of all the potential replacement properties identified.

IRS regulations do not require that a sale contract be in place at the end of 45 days, only that written notice is provided. However, to ensure that the replacement property transaction closes within another important time restrictions of the 1031 rules – namely the 180-Day Rule For Receipt of Replacement Property – it is good practice to have (or be close to finalizing) a sale contract for the replacement property.

Once the 45 days expire, it is impossible to close on any replacement property not identified under the 45-Day Rule for Identification. In this case, the exchange would fail.

To learn more about 1031 exchanges or our qualified intermediary and replacement property locator services, please visit our website.