Previously, I discussed the importance of advanced planning, in facilitating a successful 1031 Exchange and this week I want to address deadlines. Timing is everything when you are trying to execute a successful 1031 Exchange. When I’m working with my clients, I always say “that the Capital Gains tax deferral offered via IRC Section 1031 is likely the most significant tax break the IRS will ever provide,” but let me tell you, they don’t make it easy.
For those of you who may not know: once you close on the relinquished property, you have 180 days to close on your replacement property. That may seem like more than enough time, but you need to identify your replacement property within the first 45 days of those 180 days. Also, you must designate in writing with your Qualified Intermediary. Once the 45th day ends, there are no changes allowed with zero exceptions.
The timeline for a 1031 Exchange looks like this:
- Close on the sale of your relinquished property.
- Find suitable, like-kind replacement property (or properties, you will need a backup plan).
- Once you find a suitable replacement property, negotiate a purchase price (there is usually a fair amount of negotiating at this stage).
- Go to contract (which requires more negotiation before a contract is agreed upon and executed)
- Put down a deposit.
- Perform due diligence usually 30 days, sometimes 60 days, sometimes more time is required. Once the due diligence period ends, your deposit usually becomes nonrefundable, and you set a closing date.
If you are financing the purchase, you need to be shopping for a loan concurrently.
There is a lot to consider here…And the deal can potentially breakdown at any point in this timeline…
If the deal breaks down and you have no backup plan, you have no exchange. It’s as simple as that.
What can you do to ensure the best possible chance to complete your exchange in the allowable time frame?
First, start shopping for replacement property in advance of closing on your relinquished property. Look for several properties. If you find something you are interested in, consider making an offer. Make offers on multiple properties. It may seem premature at first, but if you can negotiate a purchase price before closing on your relinquished property, you’re ahead of the game. If you can’t come to terms on price, you won’t waste a valuable spot on the identification form. The 45-day clock always seems to tick a little faster than usual. Buy as much extra time as you can.
Second, identify as many properties as you can. But, only identify properties you have a realistic chance to close on.
Rules for Identification:
- The Three-Property Rule – Identify no more than three properties. You can settle on any number of or all these properties.
- The 200% Rule – Identify as many properties as you desire, as long as the aggregate value does not exceed 200% of the value of your relinquished property. You may close on any number of or all these properties.
- The 95% Rule – Identify as many properties as you desire, but you MUST close on 95% of the identified properties. This rule is rarely used because it is very risky.
Remember, this is a summary of the rules. If you are planning a 1031 Exchange make sure to work with an Advisor that has a thorough knowledge of the rules. If you do this wrong, you may invalidate your exchange. And making sure you work with an experienced advisor can help ensure you minimize the risk associated with a 1031 Exchange.
Third, if your first choice isn’t progressing towards a closing, move on to another option. Don’t wait so long that another option is no longer an option. With proper guidance from your advisor, you should be able to recognize when you need to move on.
Last, and most importantly, work with an experienced 1031 Exchange replacement property Advisor. Work with someone who has “seen it all.” The right person can lead you through a successful exchange on time.
If you have any questions, please feel free to reach out to me!
Eric Bicknese
Investment Advisor at Nationwide Planning Associates, Inc.
Eric Bicknese is an Investment Advisor Representative with NPA Asset Management, LLC. He is also a Registered Representative with Nationwide Planning Associates, Inc., a Broker/Dealer member FINRA/SIPC. He has developed a unique specialty in teaching investors how to preserve and protect their assets, reduce and potentially eliminate estate tax and defer capital gains tax on Real Estate and other appreciated assets.
A seasoned investment professional, he has served the needs of sophisticated investors since 1996. He holds Series 4, 7, 24, 63 and 65 securities registrations. He is a licensed Real Estate Sales Person in the state of New York. In addition, he is licensed by the New York, New Jersey and Florida State Insurance Departments.
