What is the 1031 Exchange 200% Rule? What is the 1031 Exchange 200% Rule?
The 1031 exchange process is a complicated but crucial process for real estate investors to understand if they want to defer capital gains tax on property transactions. By familiarizing yourself with Section 1031 of the U.S. Tax Code, the rules of 1031 exchanges, and of course consulting with a Qualified Intermediary, you'll create a path to potential wealth building by deferring capital gains taxes through the sale of an investment property in exchange for a like-kind replacement property.
One of the most important rules of the 1031 exchange process is called the 200% Rule. Below, we'll explore what the 200% Rule is, two exceptions to the 200% Rule, how it works, what the benefits are, and more.
Key Takeaways:
- The 200% Rule states that an exchangor may identify any number of like-kind replacement properties, provided the aggregate fair market value of all property identified does not exceed 200% of the sale price of all property relinquished through the exchange.
- There are two exceptions to the 200% Rule:
- The 200% Rule only applies when an exchangor identifies more than three like-kind replacement properties on or before their forty-five day identification deadline.
- If an exchangor identifies more than three like-kind replacement properties and the aggregate fair market value of those properties exceeds 200% of the sale price of all property relinquished through the exchange, then the exchangor must purchase 95% of the aggregate value of the property identified.
- The main advantage for exchangors in using the 200% Rule is increased flexibility.
1031 Exchange 200% Rule Basics
A 1031 exchange allows real estate investors (also known as an exchangor in the 1031 exchange context) to exchange a property for a like-kind replacement property to defer capital gains taxes. Section 1031 of the U.S. Tax Code has many rules that must be followed in order for an exchangor to complete a 1031 exchange. One of these rules is that any replacement property that may be purchased through the exchange must be identified in writing by midnight on the forty-fifth calendar day following the sale of the relinquished property. Additionally, there are rules limiting the quantity and aggregate value of replacement property being identified through an exchange. It is here that the 200% Rule comes into play.
The 200% Rule states that an exchangor may identify any number of like-kind replacement properties, provided the aggregate fair market value of all property identified does not exceed 200% of the sale price of all property relinquished through the exchange.
It is important to note that there are two exceptions to the 200% Rule:
First, the 200% Rule only applies when an exchangor identifies more than three like-kind replacement properties on or before their forty-five day identification deadline. This means that an exchangor may identify up to three like-kind replacement properties without any regard to the total value of those properties.
Secondly, if an exchangor identifies more than three like-kind replacement properties and the aggregate fair market value of those properties exceeds 200% of the sale price of all property relinquished through the exchange, then the exchangor must purchase 95% of the aggregate value of the property identified.
It's important to note that if an exchangor identifies more than 200% of the sale price of all property relinquished through the exchange and does not purchase 95% of the total value of the property identified, then the exchange may be invalidated and the exchangor would not defer any capital gains taxes from the sale of that relinquished property.
These rules are not one size fits all when it comes to 1031 exchanges. An experienced Qualified Intermediary like the team at Leader1031 can help you determine the best path through the 1031 exchange process for your specific investment goals.
What are the Advantages of the 200% Rule in a 1031 Exchange?
The main advantage for exchangors in using the 200% Rule is increased flexibility. An exchanger may use this Rule to purchase more than three properties through their exchange or to identify back-up properties to purchase in the event the property they are primarily targeting does not proceed or cannot close within timeline required by Section 1031 of the U.S. Tax Code. Ultimately, the Rule can prevent an exchanger from having their exchange fail from unexpected or uncontrollable circumstances.
How Real Estate Investors Can Get Started With a 1031 Exchange
Finding the right qualified intermediary to work with is crucial to the 1031 exchange process because it helps verify the security of your funds and provides your entire team with knowledge and experience that they might not otherwise have.
Your qualified intermediary will interact with your realtor, tax advisor, escrow professional, attorney, and representatives for the property you are purchasing, so it's extremely important to make sure you choose a QI who can guide your team through the complexities of the process while meeting all of the important associated deadlines.
Leader Bank's 1031 exchange subsidiary, Leader1031*, serves as a qualified intermediary for real estate investors seeking to sell and purchase property using the tax-deferred advantages of a 1031 exchange. These services provide greater integration and efficiencies for our commercial real estate clients, and Leader1031 is committed to providing the highest quality of service.
As soon as your relinquished property has gone into contract, you can set up a 1031 Exchange account with Leader1031. This 1031 Exchange account and certain documentation provided by your QI must be in place prior to the close of your relinquished property sale.
Leader1031 is ready to help ensure your transactions are in full compliance with IRS Code Section 1031. Contact Leader1031 today.
It is imperative that you also consult with your own tax and legal counsel. Leader1031 is prohibited from providing tax and legal counsel as a qualified intermediary under the IRS Code Section 1031.
The content of this publication is provided as general information only and should not be taken as legal, investment or other professional advice. This content of this publication shall not be construed as a recommendation to participate in any particular trading, financial or investment strategy, and neither Leader Bank, NA nor Leader1031.com, LLC can provide legal or tax advice concerning the specific tax consequences of a given transaction. Any action that you take as a result of information or opinions provided in this publication is ultimately your responsibility. Consult your attorney, accountant, or tax professional before making any investment or financial decisions.
To ensure compliance with requirements under Treasury Department Circular 230, we inform you that the contents of this publication are not intended or written to be used, and may not be used, for the purpose of (i) avoiding U.S. federal tax penalties or (ii) promoting, marketing, or recommending to another party any matter addressed herein. Each taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax adviser.
