1031 Exchanges: The Three-Property Rule

Real estate investors can use 1031 exchanges to minimize capital gains taxes when selling pieces of investment property. When using this technique, the seller must follow a number of rules. One of these rules is known as the three-property rule, and it is vital to the completion of the 1031 exchange. Here are the basics of the 1031 exchange and how the three-property rule applies to it.

1031 Exchange

A 1031 exchange is a method an investor can use to sell a property and purchase another one without having to pay capital gains taxes on the first property. With this strategy, an individual can sell an investment property and then use that money to purchase another property of like kind. As long as the individual abides by the rules of the 1031 exchange and purchases the new property within a certain amount of time, she can defer paying any capital gains taxes on the first sale.

The Details

If the investor does not abide by the rules of the 1031 exchange, the sale will not apply to this section of the law. At that point, she would be forced to pay capital gains taxes on the money that she earned. In order to facilitate this process, the seller has to work with a qualified intermediary. This is an individual that will take the money immediately when the property is sold and keep it for her until she buys a new property. 

From the time that the individual sells the property, she has 45 days to identify new properties that she will potentially purchase. She also has 180 days to complete the purchase of the new property.

Three-Property Rule

When identifying new properties, an individual can choose to abide by the three-property rule. This rule states that the individual can identify up to three properties of any value. The seller has to find these three properties within 45 days of the sale.

Making It Official

Once the three properties are identified, the seller has to document those properties in writing. The seller has to give specific information about the properties and sign the document. Then the seller has to deliver that document to the qualified intermediary in order to prove that the 45-day deadline was met. At that point, the individual can proceed with the process of choosing one of the three properties and purchasing it.

Other Options

If an individual does not want to limit herself to three properties, she can choose another route. The individual could choose more than three properties if the total value of the properties is not more than 200 percent of the sale price of the previous property of the seller. The three-property rule simply provides you with the ability to choose three properties no matter what the value of each is. 

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