Practical 1031: How Many Possible Replacement Properties Can I Identify for My 1031 Like-Kind Exchange?

Q. How many possible replacement properties can I identify for my 1031 like-kind exchange?

A. As noted in our prior Practical 1031 Q&A, a taxpayer must “identify” the property that the taxpayer wants to purchase as replacement property. This must be done within 45 days of the date of sale of the taxpayer’s old property. Identification is made to the qualified intermediary (QI) whom the taxpayer hired to facilitate the exchange. The QI will usually provide a form for this. Closing on the identified replacement property must occur within 180 days of the date of sale of the taxpayer’s old property.

Recognizing the practical difficulty of closing on the one replacement property the taxpayer can identify in the short 45-day identification period (and the possibility that the seller of the replacement property may ultimately decide not to sell or meet the taxpayer’s price, or that due diligence on a property may reveal that the property is unsuitable for purchase, etc.), the Treasury Regulations permit a taxpayer to identify more than one potential replacement property.

Here are the three rules for identifying multiple replacement properties:

3-Property Rule. A taxpayer may identify any three potential replacement properties. The taxpayer can acquire any one or more or all three of the identified properties.

200 Percent Rule. A taxpayer may identify more than three potential replacement properties if the total fair market value of all of the identified properties does not exceed 200 percent (2x) of the fair market value of the old property that the taxpayer sold.

So, what is fair market value? The fair market value of the taxpayer’s old property sold in the exchange should be its selling price. But how do we value the potential replacement properties? Should we use the seller’s asking price for the identified replacement property, or should we use the price that the taxpayer would be willing to pay? Or is it something higher, lower, or between the bid and ask? If, by the 45th day, a possible replacement property is under contract, then the contract price is a good indication of the fair market value of the identified property. But not all potential replacement properties are under contract by that time. So, what number should one use when applying the 200 percent rule? As a general rule, we counsel our clients to use the sellers’ asking prices (if available). That is not because the asking price is necessarily indicative of a property’s fair market value as much as it the conservative position to be taken given that even one dollar over the 200 percent limit will nullify all the taxpayer’s identifications and invalidate the entire exchange. As with the 3-property rule, a taxpayer can acquire any one or more or all the properties identified under the 200 percent rule.

95 Percent Rule. An infrequently used rule allows a taxpayer to identify more than three potential replacement properties that have a total fair market value that exceeds 200 percent of the fair market value of the taxpayer’s old property if the taxpayer ultimately acquires (within the 180-day exchange period) identified properties that have a total fair market value of at least 95 percent of the total fair market value of the properties identified.

Consider the following example of a taxpayer who sold his old property for $12 million and identified the following properties as replacement properties:

Property	Fair Market Value
A	$5,000,000
B	$1,000,000
C	$18,000,000
D	$9,000,000
Total	$33,000,000

More than three properties were identified, so the 3-property rule cannot be used. The total fair market value of the four properties identified exceeds $24 million (two times the $12 million fair market value of the old property), so the 200 percent rule cannot be used.

Under the 95 percent rule, the taxpayer’s identification is valid if the taxpayer acquires all four of the identified properties. But let us assume that the taxpayer was unable to acquire Property B. Since the total fair market value of properties A, C, and D represent more than 95 percent of the fair market value of all of the identified properties, the identification is valid and the resulting exchange is successful.

Now let us assume that that the taxpayer was only unable to acquire Property A. Since the total fair market value of properties B, C, and D represent less than 95 percent of the fair market value of all of the identified properties, the taxpayer’s identification will not be valid and the exchange will fail — even though the taxpayer could have covered his exchange with Property C alone, or with properties A and D alone. One can see then, the practical difficulty of relying on the 95 percent rule. It is worth noting that one can identify a replacement property at any time during the 45-day identification period. You can add to the list of identified properties at any time during that period. And identifications made can be revoked and replaced during that same 45-day identification period. Testing for compliance with the multiple property identification rules is made at the close of the identification period.