The identification period in an IRC Section 1031 delayed exchange begins on the date the taxpayer transfers the relinquished property and ends at midnight on the 45th calendar day thereafter. To qualify for a 1031 tax-deferred exchange, the tax code requires identifying replacement property:
- In a written document signed by the taxpayer;
- Hand-delivered, mailed, telecopied, or otherwise sent;
- Before the end of the identification period (within 45 calendar days);
- To either the person obligated to transfer the replacement property to the taxpayer (generally the qualified intermediary) or any other person involved in the exchange other than the taxpayer or a disqualified person.
The replacement property must be unambiguously described (i.e. legal description, street address or distinguishable name). In a personal property exchange the type of property should be described.
45/180 DAY EXCHANGE
The time requirements in a 1031 exchange are very specific. From closing on the sale of the relinquished (sale) property, a taxpayer must:
- Properly identify potential replacement properties within 45 calendar days (the”Identification Period”)
- Close on the replacement properties within 180 calendar days of the relinquished property sale – OR – the due date (including extensions) for the taxpayer’s tax return for the taxable year in which the reliquished property was tranferred, whichever is earlier (the “Exchange Period”)
Taxpayers acquiring property which is being constructed must identify the property and the improvements in as much detail as is practical at the time the identification is made. Taxpayers who intend to acquire less than a 100% ownership interest in the replacement property should specify the specific percentage of interest. Taxpayers should always consult with their tax and/or legal advisors about the specific identification rules and restrictions.
Any properties acquired by the taxpayer within the 45-day identification period are considered properly identified. A taxpayer has the ability to substitute a new replacement property or properties by revoking a previous identification in the same manner as originally identifying and subsequently identifying new replacement properties as long as this is done, in writing, within the 45-day identification period. Although taxpayers can identify more than one replacement property, they must adhere to one of the three rules of identification listed below:
- Three replacement properties without regard to their fair market value (“3 Property Rule”);
- Any number of replacement properties so long as their aggregate fair market value of all replacement property does not exceed 200% of the aggregate fair market value of all relinquished properties (“200% Rule”);
- Any number of replacement properties without regard to the combined fair market value, as long the replacement properties acquired amount to at least ninety-five percent of the fair market value of all identified properties (“95% Rule”).
WHAT COSTS CAN BE DEDUCTED?
A frequently asked question is “What expenses can be deducted from the exchange proceeds without resulting in a tax consequence?” Although the IRS has not published a complete list of qualifying expenses, there are some rulings that provide general parameters. Brokerage commissions can be deducted from the exchange proceeds (Revenue Ruling 72-456). Other transactional costs may also be able to be deducted if they are paid in connection with the exchange. (Letter Ruling 8328011).
WHAT ARE “EXCHANGE EXPENSES?”
Transaction costs that are referred to as “exchange expenses” on Form 8824 are not specifically listed but should generally include costs that are:
A direct cost of selling real property, which typically include:
- Real estate commissions.
- Title insurance premiums.
- Closing or escrow fees.
- Legal fees.
- Transfer taxes.
- Notary fees.
- Recording fees.
Costs specifically related to the fact the transaction is an exchange such as the Qualified Intermediary fees.
ITEMS THAT ARE NOT “EXCHANGE EXPENSES”
Although not a complete list, the costs related to obtaining the loan should not be deductedfrom the proceeds.
THESE “NON-EXCHANGE EXPENSES” INCLUDE:
- Mortgage points and assumption fees
- Credit reports
- Lender’s title insurance
- Prorated mortgage insurance
- Loan fees and loan application fees
OTHER “NON-EXCHANGE EXPENSES” CAN INCLUDE:
- Property taxes
- Utility charges
- Association fees
- Hazard insurance
- Credits for lease deposits
- Prepaid rents and security deposits
These rough guidelines do not address every potential cost. Exchangers should review their specific transaction and closing costs with their tax and/or legal advisors.