What are the ID requirements in a 1031 exchange?
Q: I am considering a 1031 exchange. What are the ID requirements?
A: There are a number of rules regarding identification of replacement property that cover how many properties you can identify, as well as how and when to properly identify them.
First, there are three rules that limit the number of properties that can be identified. The taxpayer must meet the requirements for at least one of these rules:
1. Three Property Rule: The taxpayer can identify up to three replacement properties without regard to their value.
2. 200% Rule: Any number of properties may be identified, but their total value cannot exceed twice the value of the relinquished property.
3. 95% Rule: The taxpayer may identify as many properties as he wants but, before the end of the exchange period, he must acquire replacement properties with an aggregate fair market value equal to at least 95% of the aggregate fair market value of all of the identified properties.
It has been our experience that approximately 90% of exchangers identify replacement property by meeting the requirements of the Three Property Rule. Normally this works well because the value of any singular replacement property typically equals or exceeds the value of the relinquished property sold. (Also, when the value of all three potential properties are added, the sum exceeds 200% of the value of the relinquished property.)
Secondly, there are requirements on how the letter should be sent.
IRS Regulations require that the taxpayer send an identification letter listing their potential replacement properties within 45 days of the sale of the relinquished property. The letter must be signed by the taxpayer or their legal agent. It must be sent to either the party obligated to transfer the replacement property or to any other person involved in the exchange that is not a disqualified person .
Most commonly, the exchanger will scan and email or fax the signed ID letter to the Qualified Intermediary (QI). Others follow up by sending the original hard copy by certified mail. If it is sent by fax, the taxpayer should request an acknowledgement back from QI indicating when the letter was received. If sent by email, the taxpayer should print out a dated copy for their tax file.
Thirdly, there are rules on how the properties must be described.
Property identified must be described in a such a way that it cannot be confused with other property; therefore, the use of a complete address (street number, city, state, zip code) should be sufficient. Unplatted or rural tracts of land can be more challenging. A copy of a plat or survey may be necessary. When using the 200% rule, it is advisable to not only list the complete address but also the asking price.
Finally, there is a deadline on when the ID letter must be received.
The identification letter must be received by the Qualified Intermediary within 45 days of the sale of the relinquished property. There are no exceptions to the 45-day identification deadline except for an exchanger considered to be an “affected party” for a Presidentially declared disaster.