To meet the requirements of §1031, both Relinquished Property and Replacement Property must qualify. In other words, both the property you are selling and the property you are buying must be qualified property of like-kind. If not, your exchange will fail and be classified as a sale. This is so important, that it bears repeating:
TO QUALIFY AS A LIKE-KIND EXCHANGE, THE PROPERTY MUST BE BOTH (1) QUALIFYING PROPERTY, AND (2) LIKE-KIND PROPERTY.
Some properties have more than one classification at the time of sale. For example, a farmer sells his farm including his personal residence. The sale or exchange is allocated between the real estate held for personal use (the personal residence) and the real estate held for use in a trade or business (the farm). Another example is the sale or exchange of a duplex where the seller lived in one unit and rented out the other unit.
Under §1031, both business and investment property qualify. And it does not require only business property for business property or investment property for investment property. You can mix the classifications. For example, you can exchange a commercial warehouse (business property) for two unimproved lots (investment property). Or, a 100 acre tract of land (investment property) for an apartment building (business property). All could qualify.
The 45-day Identification Rule
The Internal Revenue Code requires that you identify your potential replacement properties within 45 days of the closing on the sale of your relinquished property. The 45 days are calendar days, so if the 45th day is Sunday, Labor Day or the 4th of July, that day is still the deadline for identification of new properties. There are no extensions allowed.
There are two ways to comply with the 45-day identification requirement. The first way is to have already purchased your replacement property. If you meet all of the exchange value requirements by using all of your sale proceeds; purchase equal or greater in value; and have replaced any debt relief from the sale; and done so within the 45 day period following closing of your relinquished property, your exchange is complete at that point.
In the event you haven’t closed on a replacement property and met all of the exchange value requirements within 45 days, you must identify your new property. By midnight of the 45th day, you must compile a list of properties that you’re thinking about purchasing to replace the property you just sold. The list must be specific: it must show the property address, the legal description, or other means of specific identification.
The 3-Property Rule – You can identify up to three potential replacement properties without regard to fair market values of the properties.
The 200 Percent Rule – You may identify any number of properties as long as their fair market value does not exceed 200 percent of the total fair market value of all Relinquished Property (ies).
EXAMPLE – On January 1st you sell your only relinquished property for $100,000. On or before February 14th you want to identify four potential replacement properties: four condominiums selling for $75,000 each.
In doing so you will have violated the 45-day rule because the four properties identified exceed 200% of the value of the property sold.
The 180-day Exchange Rule
Section 1031 requires that you purchase one or more new properties by the 180th day after the closing of the old property. You must purchase one or more properties on your 45-day identification list.