A 1031 exchange allows you to defer capital gains taxes and depreciation recapture by replacing an investment property with one or more replacement properties. Did you know that investors with multiple properties can defer multiple gains by coordinating sales and exchanges? However, when multiple properties are involved, complexity may result. The following brief overview explains some of the rules and strategies involved in a multi-property 1031 exchange.
45-Day and 180-Day Rules
When engaging in a standard 1031 exchange, you must meet two key deadlines:
- First, you have 45-days from the sale of your relinquished property to identify one or more replacement properties.
- Second, you have 180 days from the sale of the relinquished property to close on at least one of the identified replacement properties.
It may be desirable for investors who own multiple investment properties to sell more than one property in a single exchange. This could provide more funds to purchase replacement properties and potentially lower exchange fees.
When relinquishing multiple properties, both the 45-day and 180-day periods begin when the sale of the first property closes. In some cases, it may be advantageous to engage in multiple exchanges instead of a single exchange. This would allow for separate 45-day and 180-day periods for each property sold.
However, it’s important to note that while multiple exchanges provide additional flexibility in terms of timing, this strategy also creates additional costs.
Identifying Multiple Replacement Properties
When relinquishing more than one property in a single exchange, the IRS outlines specific rules pertaining to the identification of multiple replacement properties. You may either:
- List up to three replacement properties regardless of their value, or
- List more than three replacement properties as long as their combined value does not exceed 200% of the total gross value of the properties being sold.
When a single replacement property is acquired from the proceeds of several exchanges, it’s typically necessary to specify the fractional interest of the property you’ll purchase in each exchange. This allows you to show that you’ve acquired substantially the same property value you’ve identified in each exchange.
Planning the Time of Your Closings
When exchanging multiple properties, planning can go a long way. For example, property sales in a multiple property exchange must close before you purchase any replacement properties. You can help ensure this happens by delaying the closing on some of your relinquished properties until you’ve secured buyers for the remaining properties and are able to close on them all in a short amount of time. Leasing the properties to potential buyers until the closing date may help you execute this strategy.
As an alternative, you may decide to delay the purchase of your desired replacement property until you can find buyers for your relinquished properties, allowing each transaction to close within the allowed timeframe.
Reverse 1031 Exchange
A reverse 1031 exchange can help investors avoid the challenges of finding a suitable replacement property within the allowed deadlines. This option allows an investor to indirectly purchase a desirable replacement property prior to selling any relinquished properties. The purchase is typically completed on behalf of the investor by an experienced Qualified Intermediary who temporarily holds title to the property pending sale of the relinquished property or properties. Funds to complete the purchase of the replacement property are provided by the investor – which may be challenging prior to receiving sales proceeds the relinquished properties.
In a variation of this process, an investor is allowed to also complete a partial reverse exchange when multiple properties are being sold. For example, if you close on your first relinquished property, and then close on your replacement property before the sale on the second property, you could complete a delayed exchange followed by a reverse exchange to extend your time limits.
While the reverse exchange must be completed within 180-days of acquiring the replacement property, investors may be able to secure a more desirable replacement property.
If the reverse exchange process sounds complex – it is. It is also more costly due to the need for the investor to not only fund the purchase of the replacement property – and pay higher fees to the Qualified Intermediary for assisting to complete the exchange. These considerations tend to limit the appeal of reverse exchanges.
The variety of the options above reflects how creativity and careful analysis can be utilized to optimize tax benefits when exchanging multiple properties.
Seek Advice from Qualified Professionals
Since 1031 exchanges involving multiple properties can be far more complex, it’s important to work with professionals who are well-versed in the process. This may include your tax professional, attorney, and real estate professional.
To learn more about the 1031 exchange process and how it may work with your portfolio, contact us to schedule a consultation with one of our advisors.
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