- The 3 Property Rule: This rule allows an investor to identify up to three potential replacement properties, regardless of their total value. While this rule seems straightforward, it often poses challenges when investors are uncertain about the closing viability of their chosen properties. If the investor cannot close on any of the three identified properties, the exchange might fail, leading to a tax liability.
- The 200% Rule: An alternative to the 3 Property Rule, the 200% Rule permits an investor to identify any number of replacement properties, as long as their combined fair market value doesn’t exceed 200% of the sold property’s value. This offers flexibility in choice but can be complex in its execution. Identifying properties whose combined value slightly exceeds the 200% limit can jeopardize the exchange.
- The 95% Exception: This exception comes into play if an investor surpasses the aforementioned rules. If an investor identifies properties beyond the limits of the 3 Property Rule and the 200% Rule, they must acquire properties that amount to at least 95% of the total value of all identified properties. This can be a risky strategy, as failing to meet the 95% acquisition threshold can invalidate the entire exchange, subjecting the investor to potential capital gains taxes. This option works well for DSTs and Cooperatives, as the investor purchases shares. This allows an investor to diversify risk by spreading their investment across various DST assets.
In light of these rules and exceptions, meticulous planning, accurate valuation, and often expert consultation are imperative to navigate the 1031 exchange landscape successfully. Our experts at 1031Max are dedicated to helping you navigate the complexities of any 1031 exchange.
