The Implementation & Execution of the §1031 45-day Notice

45 Days may seem like an eter­ni­ty if you are wait­ing for a spe­cial event. How­ev­er, the days tick by quick­ly if you are involved with a §1031 exchange. Accord­ing to the IRS the 45 days are cal­en­dar days not busi­ness days. 

July 25, 2024

By Al DiNi­co­la, AIF®, CEPA™
DST 1031 Spe­cial­ist
NAMCOA® — Naples Asset Man­age­ment Com­pa­ny®, LLC
Secu­ri­ties offered through MSC-BD, LLC Mem­ber of FINRA/SIPC

If the 45th day ends on a hol­i­day or Sun­day, it does not mat­ter.  Your list of replace­ment prop­er­ties must be sub­mit­ted and prefer­ably acknowl­edged by the Qual­i­fied Inter­me­di­ary (QI) by the end of the 45^th day. There are sev­er­al nui­sance investors attempt­ing to uti­lize a tax defer­ral strat­e­gy such as a §1031 exchange should be aware of in order to take full advan­tage of the strat­e­gy.  We will pro­vide sev­er­al exam­ples and pit­falls to avoid.

45-Day defined:

In a like kind exchange or §1031 exchange the investor is per­mit­ted to defer cap­i­tal gains tax­es on invest­ment prop­er­ty that has appre­ci­at­ed in val­ue when it is sold. One of the pro­vi­sions of this strat­e­gy is to abide by the IRS rules that involve the prop­er­ty being relin­quished, the prop­er­ty being acquired also known as the replace­ment prop­er­ty and the use of a Qual­i­fied Inter­me­di­ary (QI).  We have already cov­ered the need for a QI in a pre­vi­ous arti­cle ( Role of QI in §1031).  Once the relin­quished prop­er­ty is sold (and QI is hold­ing the pro­ceeds) the investor has a total of 45 days to iden­ti­fy poten­tial replace­ment prop­er­ties.

Replace­ment prop­er­ty iden­ti­fi­ca­tion option. The investor has three basic meth­ods to iden­ti­fy replace­ment prop­er­ty.

• Three prop­er­ty rule- iden­ti­fy up to three prop­er­ties regard­less of their val­ue.
• 200% prop­er­ty rule- iden­ti­fy as many prop­er­ties pro­vide the aggre­gat­ed val­ue does not exceed 200% of the required replace­ment val­ue (includ­ing debt)
• 95% prop­er­ty rule- iden­ti­fy as many prop­er­ties as the investor desired as long as investor clos­es on 95% of the iden­ti­fied prop­er­ties.
• Investors must sub­mit iden­ti­fied prop­er­ties to QI pri­or to the expi­ra­tion of the 45-day peri­od.
• §1031 Com­pli­ca­tion: The biggest chal­lenge fac­ing many investors with­in the 45-day peri­od is to iden­ti­fy poten­tial prop­er­ties, pre­form due dili­gence and inspec­tion, if a loan is required apply for the loan and be approved and remov­ing any oth­er con­tract con­tin­gen­cies. The oth­er chal­lenge is to ensure the sale does not fall apart between the 45 days and clos­ing. (Side note: We have suc­cess­ful­ly assist­ed investors who con­tact­ed us with less than sev­en (7) days remain­ing in the iden­ti­fi­ca­tion peri­od).

There are many arti­cles we have writ­ten that focus on the oth­er require­ments of the 1031 exchange such as replace­ment val­ue, using all the pro­ceeds, and replac­ing the debt that may have been sat­is­fied when the relin­quished prop­er­ty was sold.  What we need to focus on is the exe­cu­tion of the 45-noti­fi­ca­ton form need­ed by the QI.

Form & Func­tion:

Most QIs will pro­vide a form (poten­tial­ly a fill in the blank) for investors to com­plete that will iden­ti­fy their poten­tial replace­ment prop­er­ty. We have assist­ed investors with pro­vid­ing the option to mod­i­fy the func­tion­al­i­ty of the form (not the con­text) so that the investor may fill in the blanks so to speak.  Hav­ing a writable PDF to enter prop­er­ty infor­ma­tion may assist the investors espe­cial­ly when there may be changes made dur­ing the 45- day peri­od.

Drop and Add:

 Investors may drop and add dif­fer­ent prop­er­ties dur­ing the 45 days.  An impor­tant step would be to date each sub­mit­ted change to the form as well as declar­ing the pre­vi­ous list or form is void. For exam­ple, if your first prop­er­ty you iden­ti­fied was sold, no longer avail­able, or unac­cept­able for any rea­son you can sub­sti­tute anoth­er prop­er­ty.  Under the three-prop­er­ty rule there would be a lim­it of three prop­er­ties.  Under the 200% rule the total val­ue of the prop­er­ties on the list can­not exceed 200% of the relin­quished property’s val­ue.

Part­ner­ship and Frac­tion­al Own­er­ship:

If the replace­ment prop­er­ty may be a per­cent­age of own­er­ship sit­u­a­tion as in the case of a ten­ant in com­mon, part­ner­ship or Delaware Statu­to­ry Trust (DST) there should be an indi­ca­tion of the per­cent­age of own­er­ship in the prop­er­ty.  This iden­ti­fi­ca­tion may be in a per­cent­age amount under the three-prop­er­ty rule, or a dol­lar amount as well as a per­cent­age amount under the 200% rule.

Prop­er­ty Iden­ti­fi­ca­tion:

Each prop­er­ty that is on the poten­tial replace­ment list needs to be prop­er­ly iden­ti­fied.  Most of the time this is the prop­er­ty address or tax iden­ti­fi­ca­tion.  Occa­sion­al­ly there may be a large par­cel that relies on the ‘metes and bounds’ method of iden­ti­fi­ca­tion.  DSTs do typ­i­cal­ly have an address asso­ci­at­ed with each prop­er­ty. Investors who seek to uti­lize DSTs for diver­si­fi­ca­tion will need to include all the address­es of the prop­er­ties.  For exam­ple, if an investor is sell­ing a $900,000 prop­er­ty that investor may divide the pro­ceeds among three DSTs pro­vid­ing a diver­si­fied strat­e­gy. Diver­si­fi­ca­tion attempts to min­i­mize risk but does not guar­an­tee. If the investor was sell­ing the same $900,000 prop­er­ty and paid off a mort­gage of $200,000 then the investor would look to have a DST with non-recourse lever­age assign­ment to replace the required debt.  There are DST port­fo­lios that include 15–20 prop­er­ties. In that case each prop­er­ty would need to be iden­ti­fied as well as the per­cent­age of own­er­ship in each prop­er­ty. We advise sim­ply adding an addi­tion­al page as part of the list.  Finan­cial Advi­sors who are well versed in DST can eas­i­ly pro­vide these per­cent­ages.  

75% Rule in a §1031:

There is a lit­tle-known rule when iden­ti­fy­ing a prop­er­ty that is ref­er­enced as the 75% rule (or occa­sion­al­ly the rec­i­p­ro­cal 25% rule). This typ­i­cal­ly comes into play when iden­ti­fy­ing a ten­ant in com­mon (TIC) or a par­tial own­er­ship inter­est such as in a DST. For exam­ple, if you have iden­ti­fied a replace­ment prop­er­ty (per­cent­age of inter­est or own­er­ship) in the amount of $400,000 the IRS would con­sid­er that prop­er­ty or inter­est in the prop­er­ty to be “Sub­stan­tial­ly the Same” if you acquire 75% of that val­ue or $300,000. This would be 25% less than iden­ti­fied.  (There still is the issue of need­ing to have a total replace­ment val­ue equal to what was relin­quished). In the case of a DST or TIC if the amount of own­er­ship that was iden­ti­fied was 2% (of the total prop­er­ty or asset) the exchang­er would need to acquire a min­i­mum of 75% of that amount or an inter­est equal to 1.5% of the prop­er­ty to be con­sid­ered “sub­stan­tial­ly the same”.

The Same DST as Mul­ti­ple back­ups:

A strat­e­gy we have assist­ed investors who may be torn on which tra­di­tion­al con­tract they will accept and use the same iden­ti­fied DST as a back­up.  Here is an exam­ple:

• Investor has $1,000,000 in pro­ceeds to invest (no debt to replace in this exam­ple)
• Iden­ti­fy and attempt­ed to pur­chase a tra­di­tion­al prop­er­ty for $500,000
• Iden­ti­fy a mul­ti­fam­i­ly XYZ DST as back­up posi­tion to tra­di­tion­al prop­er­ty ($500,000)
• Investor iden­ti­fies the same XYZ DST as a sec­ond replace­ment prop­er­ty in the amount of $500,000.
• A total of three prop­er­ties iden­ti­fied (total of $1,500,000)
  • One Tra­di­tion­al for $500,000
  • One Back­up of $500,000
  • One addi­tion­al for $500,000
• The tra­di­tion­al prop­er­ty is clos­ing for $500,000 and that means the investor needs to acquire anoth­er prop­er­ty for $500,000 to bal­ance the exchange require­ments on replace­ment val­ue. How­ev­er, if there was only on XYZ DST iden­ti­fied for $1,000,000 and the investor only needs an addi­tion­al $500,000 there would be a prob­lem with the exchange. This would be less than the 75% rule and not sub­stan­tial­ly the same prop­er­ty as iden­ti­fied.

Expe­ri­ence mat­ters:

We have assist­ed sev­er­al investors with back-up posi­tions that include bal­anc­ing the replace­ment val­ue as well as bal­anc­ing the debt replace­ments.  One investor (using the 200% rule) iden­ti­fied a total of 13 DST posi­tions to sat­is­fy the exchange. We work to pro­vide the best options for the investors. Call us with your ques­tions.

This is for infor­ma­tion­al pur­pos­es only, does not con­sti­tute indi­vid­ual invest­ment advice, and should not be relied upon as tax or legal advice. Please con­sult the appro­pri­ate pro­fes­sion­al regard­ing your indi­vid­ual circumstance(s).

DSTs are not for all investors. The acqui­si­tion of a DST is for accred­it­ed investors only. Con­tact your invest­ment advis­er for addi­tion­al details on how a DST may be a solu­tion to your 1031 Exchange and suit­ed for your invest­ment future. For more infor­ma­tion on how to prop­er­ly set up an IRC §1031Tax Deferred Exchange or if you are an accred­it­ed investor and would like addi­tion­al infor­ma­tion on a DST con­tact Al DiNi­co­la at 239–691-8098 or email adinicola@namcoa.com.This is not an offer to pur­chase or solic­i­ta­tion to pur­chase any secu­ri­ty, as such be made only through an offer­ing mem­o­ran­dum or prospec­tus. Invest­ing in secu­ri­ties, real estate, or any invest­ment, whether pub­lic or pri­vate, involves risk, includ­ing but not lim­it­ed to the poten­tial of los­ing some or all of your invest­ment dol­lars when you invest in secu­ri­ties. You should review any planned finan­cial trans­ac­tions that may have tax or legal impli­ca­tions with your per­son­al tax or legal advi­sor. NAMCOA, LLC is a Reg­is­tered Invest­ment Advi­sor, reg­u­lat­ed by SEC (Secu­ri­ties and Exchange Com­mis­sion).

Our cor­po­rate office is locat­ed at 999 Van­der­bilt Beach Road, Suite 200, Naples Flori­da 34108. Secu­ri­ties Offered through MSC-BD, LLC, Mem­ber of FINRA/SIPC. 8215 SW Tualatin-Sher­wood Rd, Suite 200 Tualatin, OR 97062.  MSC-BD, LLC and NAMCOA are inde­pen­dent­ly owned and are not affil­i­at­ed.