1031 Exchanges of Multiple Relinquished or Replacement Properties

Consolidation of Properties with a 1031 Exchange  

It is not uncommon for Exchangers to own more than one Relinquished Property. Oftentimes, multiple properties have been held for a long period of time and as the property owner gets older, the management headaches associated with the properties become more challenging. Selling those properties and exchanging them for a single property can make the management much simpler. On occasion, an Exchanger might have a job transfer to somewhere far from the properties. Others might wish to retire and move to another state. There may be additional benefits as well to exchanging multiple properties for a single property, such as a higher basis for depreciation, more cash flow, and upgrading the neighborhoods between the old and new property. 

Diversification of Properties 

On the other hand, investors might not want to have “all their eggs” in one basket and believe they’ll be better served with trading one property for multiple properties. Just as most people would not have all their investments in a single stock or fund, diversification can protect against some adverse conditions affecting a single property, such as gradual neighborhood degradation negatively affecting the quality of tenants. Additional considerations include the ability to have multiple property types and the chance of realizing more income from multiple properties of the same value as the Relinquished Property. Similarly, multiple properties might provide the opportunity for greater combined appreciation.  

Timing is Everything 

One of the main logistical challenges when dealing with multi-property exchanges, are the time constraints imposed by the exchange regulations. Specifically, the requirements to identify Replacement Property within 45 days of the sale of the Relinquished Property in a new exchange account and close on the purchase of an identified property within 180 days of the original sale date.   

When attempting to sell multiple properties to consolidate into one, it is difficult to control the timing on the sales. The 45 and 180-day requirements are based on the date of the sale of the earliest Relinquished Property sold as part of the exchange. So, for example, if one of three properties is sold and funds the exchange account, the Replacement Property needs to be identified within 45 days, regardless of the timing of the sale for the other two properties. Those sales could take place beyond the 45th day or not at all. To increase the likelihood of selling the second two properties within close proximity, the Exchanger may try and negotiate an extended closing date, or a lease with a Buyer purchase option. Sometimes it might be worth trying to sell the properties at a slightly less-than market value to induce a sale. 

Another option is to set up an exchange for each Relinquished Property in order to have the 45 and 180-day time limits specific to each properties close date. If that is the case, the identification of the single Replacement Property should be coordinated between the separate exchanges with the percentage of the Replacement Property which would be acquired via the funds in each account. The 3-Property and/or the 200% Rule would provide the opportunity to identify varying percentages within each exchange. For example, the first exchange with Relinquished Property # 1 identifies 45% of the Replacement Property and then the second exchange identifies the remaining 55% of the Replacement Property, once both exchanges close the Exchanger has acquired the full 100% of Replacement Property.  

A similar challenge can arise when the Exchanger may hold title to the Relinquished Properties under different tax identities. One property may be held by a spouse in his or her own name from prior to marriage and another in a two-member LLC, which is treated at a tax partnership. An exchange account can only serve one tax entity, except for a husband and wife holding personally and filing a joint tax return so an Exchanger would have to open separate exchanges for each entity trading into a single property. Similar to the above, this could be accommodated by the two exchanges identifying and acquiring as co-tenants in the percentage of equity each account would be contributing to the purchase. Exchangers residing in a community property state allows a bit more flexibility for properties owned in different entities by spouses.  

When attempting to diversify a portfolio from a single property to multiple ones, similar timing challenges can occur. The 45 and 180-day clock is going to begin upon sale. It may be difficult to identify the Replacement Properties within 45 days. Again, there may be some relief afforded by the 3-Property and/or the 200% Rule, but it can be stressful. To alleviate potential timing issues, most investors begin looking for Replacement Properties before the sale date of the Relinquished Property. 

Reverse Exchange as an Option 

Some of the time constraints inherent in a multiple property exchange can be made easier by using a reverse exchange.

For example, an Exchanger sells the first property as part of an exchange and subsequently goes under contract and has to close on the Replacement Property, but the second Relinquished Property has not closed by that time. Since an Exchanger cannot buy before selling, a Reverse Exchange can be used to preserve the ability to exchange for it once the second Relinquished Property closes through the exchange. This is sometimes referred to as a part forward and part Reverse Exchange. The forward exchange sells the Relinquished Property first and acquires a percentage of the Replacement Property, the remaining percentage of the Replacement Property is “parked” with the Exchange Accommodation Titleholder initiating the Reverse Exchange and then once the second Relinquished Property is sold, a Reverse Exchange can be completed with the remaining percentage of the Replacement Property being transferred over to the Exchanger.  

Another fact pattern arises frequently where the Exchanger finds the “perfect” Replacement Property but has not sold any of the Relinquished Property at that time. The Exchanger can also solve this through a Reverse Exchange. This keeps the Replacement Property in abatement until the Relinquished Properties are sold. Under the IRS rules, the Replacement Property can be held up to 180 days to give time for the other properties to be sold. That time limit is known as a safe harbor reverse exchange. Although falling into the safe harbor period is highly advantageous, as a result of the Bartell decision in 2017, many exchange companies will allow transactions to go on longer. 

1031 Exchanges provide investors with the opportunity to optimize their real estate portfolios without immediate tax consequences. Exchangers are able to either consolidate or diversify their portfolio depending on their specific goals and objectives. When exchanges involved multiple properties, whether on the sale or purchase side, it can increase the level of complexity and it is important for the Exchanger to be aware of all the considerations involved prior to initiating their 1031 Exchange. Awareness of how 1031 Exchange timeframes are treated for multi-property exchanges and knowing how to utilize a Reverse Exchange to combat potential challenges can be prove advantageous for investors looking to conduct a 1031 Exchange with multiple properties.  

 
The material in this blog is presented for informational purposes only. The information presented is not investment, legal, tax or compliance advice. Accruit performs the duties solely of a Qualified Intermediary, and as such does not offer or sell investments or provide investment, legal, or tax advice.