What is the 200% Rule for 1031 Exchanges?
A 1031 Exchange, also recognized as a Like-Kind Exchange, is the best tax-deferred strategy to sell your real estate property and acquire another without incurring capital gains taxes. This exchange provides the opportunity of transferring the tax liability of your current property to your new one(s).
Tax savings aren’t the only benefit to completing an exchange. More reasons to consider a 1031 Exchange are:
- To acquire a property that may provide better return on your investment.
- To diversify your investment portfolio.
- To consolidate several property investments.
- To decrease depreciation losses.
- To create generational wealth through legacy planning.
1031 exchange rules for properties can feel quite daunting, given the fact that the rules are strict and failure to comply with them will void your exchange altogether. That being said, do not fret - these rules are not as complicated as you think, especially with the help of a skilled team of a knowledgeable real estate agent and Qualified Intermediary.
One of the strategies popular for investors looking to diversify or grow their investment portfolio is trading one property for multiple replacement properties. This is when the 200% could come in handy. Let’s go over some general rules before we dive in.
The 45 Days Identification Deadline and General Rules
The owner of the property is allotted 45 days starting from the day the relinquished property closes to identify other properties for the exchange. Suppose there is more than one property to be relinquished in the exchange. In that case, the identification period begins from the closing of the first property to be exchanged.
The default rule, more commonly known as the ‘3 Property Rule’ states that an investor may identify up to three potential properties and may obtain any combination of the properties identified.
There are other alternative identification rules, one of which is known as the 200% rule.
200% Identification Rule
An investor can identify more than three potential properties so long as the total market value of all the identified properties does not exceed 200% of the total market value of the relinquished property or properties sold in the 1031 Exchange.
There are no restrictions on the number of like-kind replacement properties, only the condition of the 200% aggregate value applies.
For example, if the sold relinquished property amounts to $1,000,000, you can identify as many potential properties as you want, so long as the total value of the identified replacement properties does not exceed $2,000,000.
To note, you have to either comply with the ‘200% rule’ or the ‘3 property rule’. Not both at the same time.
When to Utilize the 200% Rule
The 200% rule comes in handy when you would want to diversify your assets by trading a higher quantity of properties for your original asset. For example, you could sell a single family residence and purchase a handful of condos, or even an industrial building for several parcels of land.
Pro tip: We recommend that investors identify properties that are worth slightly less than what is permitted in the 200% Rule in the event that some properties are later determined to have a higher value than what was initially estimated.
If you need more clarity on the 200% Rule or are interested in diversifying your portfolio through a 1031 Exchabge, contact me by filling out the form below.