By Dwight Kay, Founder and CEO; Betty Friant, Senior Vice President and the Kay Properties Team
“Is this your final answer?” You may recognize the question made famous by the popular game show Who Wants to Be a Millionaire? Choosing the correct answer in this game gives you a chance to win a lot of money, while the wrong answer leaves you with nothing. Investors who conduct a 1031 exchange face a similar decisive decision when it comes to identifying suitable replacement properties.
The right choices can help streamline a smooth and successful execution of a 1031 exchange. Making the wrong choice with properties that may not be viable or deals that cannot be closed within the 180 day time frame can do derail the entire 1031 exchange. The good news is that investors can identify more than one replacement property. However, just like the game show, once that 45-day deadline is reached to identify replacement options, those responses are final. Making the most of this short list is one of the reasons the 200% rule is a popular choice for many investors. The 200% rule allows an investor to identify the greatest number of replacement options with four or more properties or Delaware Statutory Trust (DST) replacement investments.
Under Section 1031 of the Internal Revenue Code, taxpayers seeking to defer the recognition of capital gains and federal income tax related to the sale of a property are required to formally identify a or replacement property within 45 days of the date the original property is transferred (the day they closed the receiver on the property they sold). The tax code gives taxpayers three different options for identifying replacement properties on this 45-day property identification form – the 200% rule, the 3-property rule, or the 95% rule. So what is the best option to use? Every situation is different. However, for investors who want to maximize their potential options and identify four or more replacement properties, the 200% rule is a good choice to explore.
How does the 200% rule work?
Exchangers can identify any number of properties as long as the gross price does not exceed 200% of the fair market value of the transferred property (twice the sale price). It is generally used when an investor wishes to identify four or more properties. This is the rule most commonly used by investors considering DST investments, due to the flexibility of being able to list multiple properties to form a diversified DST portfolio. The minimum investment amount for DST typically starts at $ 100,000, while most commercial real estate properties are valued above $ 1 million. So, for an investor who has $ 1 million to reinvest, he might choose to put all that $ 1 million in a single DST (which is generally not recommended even when the DST has many properties in it) , or he can split that million dollars. in up to 10 completely separate DSTs.
An important mistake to avoid is to ensure that the list of identified properties does not exceed the limit of 200%. The IRS is a stickler for the rules. If the combined price of the identified replacement properties exceeds the maximum limit of 200% – even a fraction of a percent – it will not be accepted.
Hypothetical example: broadening your options
A married couple have sold their manufacturing business which included the sale of the property that housed the business, giving the couple $ 2 million to invest in a 1031 exchange. The couple plan to retire and the two agree that they don’t want a replacement property or properties that will require hands-on management. The husband wants to buy a Triple Net Leased (NNN) fast food restaurant for $ 1.2 million, while the wife is in favor of a $ 1.5 million NNN dollar store. Both properties are listed on the 45-day form, bringing the total to $ 2.7 million. They decide to use the 200% rule, which allows up to $ 1.3 million in additional property listings.
The couple agree to split the remaining $ 1.3 million among several DST investments and choose to identify:
- $ 100,000 in a DST multi-family apartment in Denver
- $ 200,000 in a DST multi-family apartment building in Dallas
- $ 250,000 in a debt-free DST portfolio of NNN-leased pharmacies and e-commerce distribution facilities
- $ 250,000 in a DST portfolio of NNN dialysis facilities with locations nationwide
- $ 500,000 in a DST wallet of NNN dollar stores
Overall, the 200% rule allows the couple to identify these seven possible options during their 45-day period. The DSTs are all packaged and ready to use with closures that can easily be closed in a week. The couple are using the remaining time to conduct more research and due diligence on the NNN Dollar General and KFC. Ultimately, they decide to buy the KFC for $ 1.2 million, but they like the diversity of being about to buy a $ 500,000 DST stake in a portfolio of dollar stores by. report to a single location. The remaining $ 300,000 is spent in the two DST apartments.
In this case, the ability to leverage the 200% rule was beneficial by giving the couple more options and more time to make a final investment decision. The result was also successful in that their 1031 exchange was fully executed and their $ 2 million is now invested in a diverse portfolio of several income-producing properties, down from just one or two. However, it is also important to note that each situation is unique. Individuals should consider the three 1031 identification options to choose the rule that best suits your particular situation and should always speak to their CPA before making any decisions.
About Kay Properties and www.kpi1031.com
Kay Properties is a Delaware Statutory Trust (DST) national investment company. The www.kpi1031.com The platform offers access to the DST marketplace of over 25 different sponsor companies, custom DSTs only available to Kay customers, independent advice on DST sponsor companies, full due diligence and oversight over each DST (usually 20-40 DST) and a DST aftermarket. Kay Properties’ team members collectively have over 115 years of real estate experience, are licensed in all 50 states, and have participated in over $ 15 billion in DST 1031 investments.
This material does not constitute an offer to sell or a solicitation of an offer to buy securities. Such offers can only be made through the confidential Private Placement Memorandum (the “Memorandum”). Please read the entire memorandum, paying particular attention to the risk section before investing. IRC Section 1031, IRC Section 1033 and IRC Section 721 are complex tax codes, so you should consult your tax professional or lawyer for further details regarding your situation. There are significant risks associated with investing in real estate securities, including illiquidity, vacancy, general market conditions and competition, lack of operating history, interest rate risks, general risks associated with owning / operating commercial and multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks and long holding periods. There is a risk of losing all of the investment capital. Past performance is no guarantee of future results. Potential cash flows, potential returns and potential appreciation are not guaranteed. Titles offered by Growth capital services, member FINRA, SIPC, Office of Supervisory Jurisdiction located at 582 Market Street, Suite 300, San Francisco, CA 94104.