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Issue  13  Article  25
Published:  8/1/1996

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Tax Deferred Exchanges - Selected Issues
Alex Pinkston, Legal Assistant

Identification and Exchange Periods

Section 1031 of the Internal Revenue Code provides that no gain or loss will be recognized for exchanges of like-kind property which is held for productive use in a trade or business or for investment. The final regulations for IRC Sec. 1031 require replacement property to be substantially the same as property identified in the exchange; however, the regulations provide little guidance as to what property is substantially the same.

Any replacement property received within the exchange period can qualify for nonrecognition treatment, but replacement property received outside the exchange period does not qualify for nonrecognition treatment. There are strict time requirements which must be met in order to qualify for nonrecognition treatment, and failure to comply with the requirements will result in the transaction being taxable.

There are two requirements that must be complied with in order for the replacement property to qualify as like-kind. The requirements are:

1. Identification Period: The replacement property must be identified within 45 days of the date the relinquished property is transferred.

2. Exchange Period: The replacement property must be received on the earlier of

a. 180 days of the date the relinquished property is transferred; or

b. the due date of the taxpayer's tax return for the taxable year in which the transfer of the relinquished property occurs; this includes extensions.

The date on which the property is transferred is the date on which the benefits and burdens of ownership of the relinquished property are transferred; this is not necessarily the date on which a deed is dated or the date on which a deed is recorded. For example, in North Carolina, a deed passes title as between the parties without recordation. When multiple properties are transferred as part of the same transaction, the identification and exchange periods start to run on the date of the first related transfer.

There are no provisions for extending either the identification or the exchange period, even if the period ends on a weekend or a holiday, and the commissioner has no power to extend them.

Alternative and Multiple Properties

Three rules deal with designating alternative properties or overdesignating the replacement property. At least one of these rules must be satisfied, or the entire exchange will be taxable, except to the extent the taxpayer acquires replacement property before the end of the identification period. The three rules are:

1. Three Property Rule: three replacement properties may be designated without regard to their values.

2. 200% Rule: any number of replacement properties may be designated as long as their aggregate fair market value at the end of the identification period does not exceed 200% of the aggregate fair market value of all of the relinquished properties as of the date the relinquished properties are transferred.

3. 95% Rule: as many replacement properties as desired may be designated, provided the taxpayer receives identified replacement property constituting at least 95% of the aggregate fair market value of all of the identified replacement properties before the end of the exchange period.

With the 200% and the 95% rules, the fair market value of each identified replacement property is determined as of the earlier of:

1. the date the property is received by the taxpayer, if actually received during the exchange period; or

2. the last day of the exchange period, if not received during the exchange period.

With the Three Property and the 200% rules, all property identified as replacement property is taken into account, except property which has been properly revoked.

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