Category: 1031 Exchange General

The Facts
A qualified intermediary (QI) company, Accruit, received an inquiry from some taxpayers, who we will call Mr. and Mrs. Pike, regarding facilitating a real estate exchange.  The clients got in touch with Accruit on July 14, 2014.
The Pikes had entered into a contract to sell their ½ interest in a multi-family investment property located in San Francisco, California.  The contract called for a closing on August 15, 2014.  The sale price was $1,000,000.  At this point in time, the Pikes did not know what they might be acquiring as replacement property. 
The Problem
They did not want to incur any tax in connection with the sale.  Although QIs cannot give tax advice, and we did not, let’s assume their basis in the property being sold, the relinquished property, was $600,000 and their joint income was above $250,000 per year.  The basis in property is determined by the original purchase price of the property plus the cost of any improvements they added to the property and minus any depreciation they took on the property during their period of ownership.  Let’s assume they bought the property for $700,000, added $50,000 in improvements and took $150,000 in depreciation to arrive at the basis in the property.  Without an exchange they would be looking at taxes as follows:

20% capital gain on the appreciation ($250,000 x 20%)
25% recapture of depreciation taken ($150,000 x 25%)
Affordable Care Act tax ($250,000 x 3.8%)
Approximate effective rate of California capital gain ($250,000 x 9%)

The Solution: A 1031 Exchange
A tax deferred exchange, in which the Pikes would trade up or even in value and have at least the same new mortgage liability as they had on the relinquished property, would negate the payment of any tax.  The applicable forward exchange docs were prepared for the Pikes.  They executed and returned these documents consisting of the following:

Exchanger information form
Tax deferred exchange agreement
Qualified escrow agreement for the deposit and holding of the exchange funds
Assignment of rights in the relinquished property contract
Copy of the sale contract pertaining to the assignment
W-9 in connection with the interest to be earned on the deposit of the exchange funds
Copies of their drivers’ licenses

For a non-1031 exchange transaction in California, the settlement agent may have to hold back some of the sale proceeds to cover the state’s capital gains liability.  However when California taxpayers are selling relinquished property as the first step towards an exchange of property, the client will complete a form 593-C known as a “Real Estate Withholding Certificate” in order to obtain an exemption from the withholding.  The QI is then responsible for withholding should the taxpayer not utilize all the funds in the exchange account when they acquire their replacement property.
The Pikes closed on the sale of their property on July 31, 2014, and the amount of $821,377 was wire transferred to their exchange account.  Once the relinquished property sale was complete they needed to provide the following forms in order to complete their acquisition of the replacement property:

Designation notice within 45 days of the sale identifying up to three potential replacement properties (read more about the requirements for identifying replacement property)
Assignment of rights in the replacement property contract
Copy of the purchase contract pertaining to the assignment
Disbursement instructions to the QI and the escrow agent for the replacement property purchase

On August 26, 2014, the Pikes signed and returned the designation notice identifying a property in San Mateo, California as their only replacement property.  On September 3, 2014, they assigned their rights under the replacement property contract and directed the QI to put down earnest money of $23,250 in connection with the purchase of the new property.  On September 11, 2014, the QI was directed to wire transfer the additional sum of $776,414 to the settlement agent and the Pikes acquired the property at that time.
The client’s exchange account held an additional $21,176 of non-reinvested proceeds and the Pikes sought a return of that sum.  Due to California’s withholding requirement, North Star completed a California Real Estate Withholding Tax Statement (Form 593) requiring a hold back and direct payment to the State of 3.33%, or $723. North Star remitted the balance to the Pikes.
The Pike’s will file an IRS form 8824 at the end of the tax year to report their exchange transaction.
The Result
With the exception of the small amount of tax pertaining to the funds not needed in the acquisition of the replacement property, the Pikes achieved tax deferral on the sale of their relinquished property  – approximately a $112,000 savings which was reinvested in their replacement property. 
Download the https://info.accruit.com/forward-exchange-whitepaper”>1031 Forward Exchange Procedural Outline of the step-by-step processes involved in completing a tax deferred exchange, which you may review with your tax advisor.
 
Updated 2/24/2022.

The Facts
A qualified intermediary (QI) company, Accruit, received an inquiry from some taxpayers, who we will call Mr. and Mrs. Pike, regarding facilitating a real estate exchange.  The clients got in touch with Accruit on July 14, 2014.
The Pikes had entered into a contract to sell their ½ interest in a multi-family investment property located in San Francisco, California.  The contract called for a closing on August 15, 2014.  The sale price was $1,000,000.  At this point in time, the Pikes did not know what they might be acquiring as replacement property. 
The Problem
They did not want to incur any tax in connection with the sale.  Although QIs cannot give tax advice, and we did not, let’s assume their basis in the property being sold, the relinquished property, was $600,000 and their joint income was above $250,000 per year.  The basis in property is determined by the original purchase price of the property plus the cost of any improvements they added to the property and minus any depreciation they took on the property during their period of ownership.  Let’s assume they bought the property for $700,000, added $50,000 in improvements and took $150,000 in depreciation to arrive at the basis in the property.  Without an exchange they would be looking at taxes as follows:

20% capital gain on the appreciation ($250,000 x 20%)
25% recapture of depreciation taken ($150,000 x 25%)
Affordable Care Act tax ($250,000 x 3.8%)
Approximate effective rate of California capital gain ($250,000 x 9%)

The Solution: A 1031 Exchange
A tax deferred exchange, in which the Pikes would trade up or even in value and have at least the same new mortgage liability as they had on the relinquished property, would negate the payment of any tax.  The applicable forward exchange docs were prepared for the Pikes.  They executed and returned these documents consisting of the following:

Exchanger information form
Tax deferred exchange agreement
Qualified escrow agreement for the deposit and holding of the exchange funds
Assignment of rights in the relinquished property contract
Copy of the sale contract pertaining to the assignment
W-9 in connection with the interest to be earned on the deposit of the exchange funds
Copies of their drivers’ licenses

For a non-1031 exchange transaction in California, the settlement agent may have to hold back some of the sale proceeds to cover the state’s capital gains liability.  However when California taxpayers are selling relinquished property as the first step towards an exchange of property, the client will complete a form 593-C known as a “Real Estate Withholding Certificate” in order to obtain an exemption from the withholding.  The QI is then responsible for withholding should the taxpayer not utilize all the funds in the exchange account when they acquire their replacement property.
The Pikes closed on the sale of their property on July 31, 2014, and the amount of $821,377 was wire transferred to their exchange account.  Once the relinquished property sale was complete they needed to provide the following forms in order to complete their acquisition of the replacement property:

Designation notice within 45 days of the sale identifying up to three potential replacement properties (read more about the requirements for identifying replacement property)
Assignment of rights in the replacement property contract
Copy of the purchase contract pertaining to the assignment
Disbursement instructions to the QI and the escrow agent for the replacement property purchase

On August 26, 2014, the Pikes signed and returned the designation notice identifying a property in San Mateo, California as their only replacement property.  On September 3, 2014, they assigned their rights under the replacement property contract and directed the QI to put down earnest money of $23,250 in connection with the purchase of the new property.  On September 11, 2014, the QI was directed to wire transfer the additional sum of $776,414 to the settlement agent and the Pikes acquired the property at that time.
The client’s exchange account held an additional $21,176 of non-reinvested proceeds and the Pikes sought a return of that sum.  Due to California’s withholding requirement, North Star completed a California Real Estate Withholding Tax Statement (Form 593) requiring a hold back and direct payment to the State of 3.33%, or $723. North Star remitted the balance to the Pikes.
The Pike’s will file an IRS form 8824 at the end of the tax year to report their exchange transaction.
The Result
With the exception of the small amount of tax pertaining to the funds not needed in the acquisition of the replacement property, the Pikes achieved tax deferral on the sale of their relinquished property  – approximately a $112,000 savings which was reinvested in their replacement property. 
Download the https://info.accruit.com/forward-exchange-whitepaper”>1031 Forward Exchange Procedural Outline of the step-by-step processes involved in completing a tax deferred exchange, which you may review with your tax advisor.
 
Updated 2/24/2022.

The Facts
A qualified intermediary (QI) company, Accruit, received an inquiry from some taxpayers, who we will call Mr. and Mrs. Pike, regarding facilitating a real estate exchange.  The clients got in touch with Accruit on July 14, 2014.
The Pikes had entered into a contract to sell their ½ interest in a multi-family investment property located in San Francisco, California.  The contract called for a closing on August 15, 2014.  The sale price was $1,000,000.  At this point in time, the Pikes did not know what they might be acquiring as replacement property. 
The Problem
They did not want to incur any tax in connection with the sale.  Although QIs cannot give tax advice, and we did not, let’s assume their basis in the property being sold, the relinquished property, was $600,000 and their joint income was above $250,000 per year.  The basis in property is determined by the original purchase price of the property plus the cost of any improvements they added to the property and minus any depreciation they took on the property during their period of ownership.  Let’s assume they bought the property for $700,000, added $50,000 in improvements and took $150,000 in depreciation to arrive at the basis in the property.  Without an exchange they would be looking at taxes as follows:

20% capital gain on the appreciation ($250,000 x 20%)
25% recapture of depreciation taken ($150,000 x 25%)
Affordable Care Act tax ($250,000 x 3.8%)
Approximate effective rate of California capital gain ($250,000 x 9%)

The Solution: A 1031 Exchange
A tax deferred exchange, in which the Pikes would trade up or even in value and have at least the same new mortgage liability as they had on the relinquished property, would negate the payment of any tax.  The applicable forward exchange docs were prepared for the Pikes.  They executed and returned these documents consisting of the following:

Exchanger information form
Tax deferred exchange agreement
Qualified escrow agreement for the deposit and holding of the exchange funds
Assignment of rights in the relinquished property contract
Copy of the sale contract pertaining to the assignment
W-9 in connection with the interest to be earned on the deposit of the exchange funds
Copies of their drivers’ licenses

For a non-1031 exchange transaction in California, the settlement agent may have to hold back some of the sale proceeds to cover the state’s capital gains liability.  However when California taxpayers are selling relinquished property as the first step towards an exchange of property, the client will complete a form 593-C known as a “Real Estate Withholding Certificate” in order to obtain an exemption from the withholding.  The QI is then responsible for withholding should the taxpayer not utilize all the funds in the exchange account when they acquire their replacement property.
The Pikes closed on the sale of their property on July 31, 2014, and the amount of $821,377 was wire transferred to their exchange account.  Once the relinquished property sale was complete they needed to provide the following forms in order to complete their acquisition of the replacement property:

Designation notice within 45 days of the sale identifying up to three potential replacement properties (read more about the requirements for identifying replacement property)
Assignment of rights in the replacement property contract
Copy of the purchase contract pertaining to the assignment
Disbursement instructions to the QI and the escrow agent for the replacement property purchase

On August 26, 2014, the Pikes signed and returned the designation notice identifying a property in San Mateo, California as their only replacement property.  On September 3, 2014, they assigned their rights under the replacement property contract and directed the QI to put down earnest money of $23,250 in connection with the purchase of the new property.  On September 11, 2014, the QI was directed to wire transfer the additional sum of $776,414 to the settlement agent and the Pikes acquired the property at that time.
The client’s exchange account held an additional $21,176 of non-reinvested proceeds and the Pikes sought a return of that sum.  Due to California’s withholding requirement, North Star completed a California Real Estate Withholding Tax Statement (Form 593) requiring a hold back and direct payment to the State of 3.33%, or $723. North Star remitted the balance to the Pikes.
The Pike’s will file an IRS form 8824 at the end of the tax year to report their exchange transaction.
The Result
With the exception of the small amount of tax pertaining to the funds not needed in the acquisition of the replacement property, the Pikes achieved tax deferral on the sale of their relinquished property  – approximately a $112,000 savings which was reinvested in their replacement property. 
Download the https://info.accruit.com/forward-exchange-whitepaper”>1031 Forward Exchange Procedural Outline of the step-by-step processes involved in completing a tax deferred exchange, which you may review with your tax advisor.
 
Updated 2/24/2022.

Understanding the rules for identification in regards to a 1031 Exchange are essential for ensuring you are on track for a valid 1031 Exchange. The rules were established as part of the Tax Reform Act of 1984 and have remained unchanged to date. Let’s review the article below which covers the specific rules for identification, as well as receipt of replacement property.
Why is it Necessary to Identify Replacement Property?
In a typical Internal Revenue Code (IRC) §1031 delayed exchange, commonly known as a 1031 exchange or tax deferred exchange, a taxpayer has 45 days from the date of sale of the relinquished property to identify potential replacement property.  This 45-day window is known as the identification period.  The taxpayer has 180 days (shorter in some circumstances) to acquire one or more of the identified properties, which is known as the exchange period. Property(ies) actually acquired within the 45-day identification period do not have to be specifically identified, however they do count toward the 3-property and 200 percent rules discussed below.
These rules are a direct result of the Starker case where for the first time a taxpayer was found to be able to sell relinquished property on one day and acquire replacement property at a different point in time.  In fact, the Starker case involved a five-year gap between the sale and purchase.  Prior to the decision in the Starker case, it was believed that an exchange had to be simultaneous.  As a result of the open-endedness of this decision, as part of the Tax Reform Act of 1984, Congress added the 45/180 day limitation to the delayed exchange.  These time limitations were a compromise between allowing an exchange to be non-simultaneous while at the same time having some temporal continuity between the sale and the purchase.
What are the Identification and Receipt Rules?
The identification rules in a 1031 exchange include the following:

The 45-day requirement to designate replacement property
The 3-property rule
The 200-percent rule
The 95-percent rule
The incidental property rule
Description of Replacement Property
Property to be produced

The 45-day Identification Rule
The exchange regulations provide “The identification period begins on the date the taxpayer transfers the relinquished property and ends at midnight on the 45th day thereafter.”  The identification must (i) appear in a written document, (ii) signed by the taxpayer and (iii) be delivered to the replacement property seller or any other person that is not a disqualified person who is involved in the exchange.  The custom and practice is for the identification to be delivered to the qualified intermediary, however a written statement in a contract to purchase the replacement property stating that the buyer is identifying the subject property as his replacement would meet the requirements of the identification.  The restriction against providing the notice to a disqualified person is that such a person may be likely to bend the rules a bit based upon the person’s close relation to the taxpayer.  Disqualified persons generally are those who have an agency relationship with the taxpayer.  They include the taxpayer’s employee, attorney, accountant, investment banker and real estate agent if any of those parties provided services during the two-year period prior to the transfer of the relinquished property.  Property identifications made within the 45-day period can be revoked and replaced with new identifications, but only if done so within that the identification period.
The 3-Property Rule
This rule simply states that the replacement property identification can be made for up to “three properties without regard to the fair market values of the properties.”  At one time in the history of §1031 exchanges, there was a requirement to prioritize identified properties.  At those times, if a taxpayer wished to acquire a second identified property, they could not do so unless the first identified property fell through due to circumstances beyond the taxpayer’s control.   Presumably this harsh requirement played a role in the 1991 Treasury Regulations where the 3-Property Rule is found.  By far and away, most taxpayers utilize this rule.
The 200% Percent Rule
The 200-percent rule states the taxpayer may identify: 

“Any number of properties as long as their aggregate fair market value as of the end of the identification period does not exceed 200 percent of the aggregate fair market value of all the relinquished properties as of the date the relinquished properties were transferred by the taxpayer.” 

Another way to state this is that the taxpayer can identify any number of properties and actually close on any number of them if the sum of the market value of all of them does not exceed twice the market value of the relinquished property.  There is some uncertainty of how the market value of these properties is determined.  The listing price? The amount the seller is willing to accept?  The amount that the taxpayer agrees to pay?  The answer is unclear but using the listing price would surely be a safe choice.
The 95% Rule
The 95-percent rule is defined as follows: 

“Any replacement property identified before the end of the identification period and received before the end of the exchange period, but only if the taxpayer receives before the end of the exchange period identified replacement property the fair market value of which is at least 95 percent of the aggregate fair market value of all identified replacement properties.”

As a practical matter, this rule is very hard to adhere to.  Basically, it provides that should the taxpayer have over identified for purpose of the first two rules, the identification can still be considered valid if the taxpayer receives at least 95% in value of what was identified.  For example, if a taxpayer identified four properties or more whose market value exceeds 200% of the value of the relinquished property, to the extent that the taxpayer received 95% of what was “over” identified then the identification is deemed proper.  In the real world it is difficult to imagine this rule being relied upon by a taxpayer.
The Incidental Property Rule in Section 1031
The incidental property rule is defined as follows: 

“Solely for purposes of applying this paragraph (c), property that is incidental to a larger item of property is not treated as property that is separate from the larger item of property. Property is incidental to a larger item of property if – (A) In standard commercial transactions, the property is typically transferred together with the larger item of property, and (B) The aggregate fair market value of all of the incidental property does not exceed 15 percent of the aggregate fair market value of the larger item of property.” 

In other words, if there is some incidental property that typically passes to a buyer in standard commercial transactions for this kind of property sale, to the extent that the value of any such property is less than 15%  of the primary property, the incidental property does not have to be separately identified.
To illustrate this rule the exchange regulations use the example of an apartment building to be acquired for $1,000,000 which includes furniture, laundry machines and other miscellaneous items of personal property whose aggregate value does not exceed $150,000.  In this example, those various items of personal property are not required to be separately identified nor does that property count against the 3-Property Rule.  Be aware however that this rule only applies to identification and not to making sure that replacement property must still be like-kind to the relinquished property.  For example, if the relinquished property was real estate with a value of $1,000,000 and the replacement property was real estate with a value of $850,000 plus incidental property of $150,000, the taxpayer will still have tax to pay (known as “ boot”) because the incidental personal property was not like-kind to the relinquished property.
Description of Replacement Property in IRS 1031 Exchange
The description of replacement property must be unambiguous and specific.  For instance, the identification of “a condominium unit at 123 Main Street, Chicago, IL” would fail due to the specific unit not having been identified.  The actual rules are as follows:

Replacement property is identified only if it is unambiguously described in the written document or agreement.
Real property generally is unambiguously described if it is described by a legal description, street address, or distinguishable name (e.g., the Mayfair Apartment Building).
Personal property generally is unambiguously described if it is described by a specific description of the particular type of property. For example, a truck generally is unambiguously described if it is described by a specific make and model.

1031 Exchange Property to Be Improved or Produced
Oftentimes, the property intended to be acquired by the taxpayer will be in a different physical state at the time it is identified than it will be upon receipt by the taxpayer.  The regulations account for this by requiring the identification for real estate to include the address or legal description of the property plus as much detail as practical about the intended improvements.  In connection with the receipt of property to be improved, even if the described improvements are not completed at the time it is received by the taxpayer, the exchange is valid so long as the actual property received does not differ from what was identified by the taxpayer except for the degree of improvements that have been completed. Personal property is a bit different in this regard and the “production” (improvements) needs to be completed within the 180-day term.
Summary
The ability to defer taxes through a §1031 exchange is a very valuable benefit to taxpayers.  However, to receive this benefit, all the exchange rules must be strictly adhered to.  The rules pertaining to identification and receipt of replacement property must be understood and met in order to comply with the technical requirements of this IRC section.  In fact, the property identification rules are so germane to a proper exchange that there is a question asked of the taxpayer on the exchange reporting form 8824 about compliance with these rules.
 

Updated 2/23/2022.

Understanding the rules for identification in regards to a 1031 Exchange are essential for ensuring you are on track for a valid 1031 Exchange. The rules were established as part of the Tax Reform Act of 1984 and have remained unchanged to date. Let’s review the article below which covers the specific rules for identification, as well as receipt of replacement property.
Why is it Necessary to Identify Replacement Property?
In a typical Internal Revenue Code (IRC) §1031 delayed exchange, commonly known as a 1031 exchange or tax deferred exchange, a taxpayer has 45 days from the date of sale of the relinquished property to identify potential replacement property.  This 45-day window is known as the identification period.  The taxpayer has 180 days (shorter in some circumstances) to acquire one or more of the identified properties, which is known as the exchange period. Property(ies) actually acquired within the 45-day identification period do not have to be specifically identified, however they do count toward the 3-property and 200 percent rules discussed below.
These rules are a direct result of the Starker case where for the first time a taxpayer was found to be able to sell relinquished property on one day and acquire replacement property at a different point in time.  In fact, the Starker case involved a five-year gap between the sale and purchase.  Prior to the decision in the Starker case, it was believed that an exchange had to be simultaneous.  As a result of the open-endedness of this decision, as part of the Tax Reform Act of 1984, Congress added the 45/180 day limitation to the delayed exchange.  These time limitations were a compromise between allowing an exchange to be non-simultaneous while at the same time having some temporal continuity between the sale and the purchase.
What are the Identification and Receipt Rules?
The identification rules in a 1031 exchange include the following:

The 45-day requirement to designate replacement property
The 3-property rule
The 200-percent rule
The 95-percent rule
The incidental property rule
Description of Replacement Property
Property to be produced

The 45-day Identification Rule
The exchange regulations provide “The identification period begins on the date the taxpayer transfers the relinquished property and ends at midnight on the 45th day thereafter.”  The identification must (i) appear in a written document, (ii) signed by the taxpayer and (iii) be delivered to the replacement property seller or any other person that is not a disqualified person who is involved in the exchange.  The custom and practice is for the identification to be delivered to the qualified intermediary, however a written statement in a contract to purchase the replacement property stating that the buyer is identifying the subject property as his replacement would meet the requirements of the identification.  The restriction against providing the notice to a disqualified person is that such a person may be likely to bend the rules a bit based upon the person’s close relation to the taxpayer.  Disqualified persons generally are those who have an agency relationship with the taxpayer.  They include the taxpayer’s employee, attorney, accountant, investment banker and real estate agent if any of those parties provided services during the two-year period prior to the transfer of the relinquished property.  Property identifications made within the 45-day period can be revoked and replaced with new identifications, but only if done so within that the identification period.
The 3-Property Rule
This rule simply states that the replacement property identification can be made for up to “three properties without regard to the fair market values of the properties.”  At one time in the history of §1031 exchanges, there was a requirement to prioritize identified properties.  At those times, if a taxpayer wished to acquire a second identified property, they could not do so unless the first identified property fell through due to circumstances beyond the taxpayer’s control.   Presumably this harsh requirement played a role in the 1991 Treasury Regulations where the 3-Property Rule is found.  By far and away, most taxpayers utilize this rule.
The 200% Percent Rule
The 200-percent rule states the taxpayer may identify: 

“Any number of properties as long as their aggregate fair market value as of the end of the identification period does not exceed 200 percent of the aggregate fair market value of all the relinquished properties as of the date the relinquished properties were transferred by the taxpayer.” 

Another way to state this is that the taxpayer can identify any number of properties and actually close on any number of them if the sum of the market value of all of them does not exceed twice the market value of the relinquished property.  There is some uncertainty of how the market value of these properties is determined.  The listing price? The amount the seller is willing to accept?  The amount that the taxpayer agrees to pay?  The answer is unclear but using the listing price would surely be a safe choice.
The 95% Rule
The 95-percent rule is defined as follows: 

“Any replacement property identified before the end of the identification period and received before the end of the exchange period, but only if the taxpayer receives before the end of the exchange period identified replacement property the fair market value of which is at least 95 percent of the aggregate fair market value of all identified replacement properties.”

As a practical matter, this rule is very hard to adhere to.  Basically, it provides that should the taxpayer have over identified for purpose of the first two rules, the identification can still be considered valid if the taxpayer receives at least 95% in value of what was identified.  For example, if a taxpayer identified four properties or more whose market value exceeds 200% of the value of the relinquished property, to the extent that the taxpayer received 95% of what was “over” identified then the identification is deemed proper.  In the real world it is difficult to imagine this rule being relied upon by a taxpayer.
The Incidental Property Rule in Section 1031
The incidental property rule is defined as follows: 

“Solely for purposes of applying this paragraph (c), property that is incidental to a larger item of property is not treated as property that is separate from the larger item of property. Property is incidental to a larger item of property if – (A) In standard commercial transactions, the property is typically transferred together with the larger item of property, and (B) The aggregate fair market value of all of the incidental property does not exceed 15 percent of the aggregate fair market value of the larger item of property.” 

In other words, if there is some incidental property that typically passes to a buyer in standard commercial transactions for this kind of property sale, to the extent that the value of any such property is less than 15%  of the primary property, the incidental property does not have to be separately identified.
To illustrate this rule the exchange regulations use the example of an apartment building to be acquired for $1,000,000 which includes furniture, laundry machines and other miscellaneous items of personal property whose aggregate value does not exceed $150,000.  In this example, those various items of personal property are not required to be separately identified nor does that property count against the 3-Property Rule.  Be aware however that this rule only applies to identification and not to making sure that replacement property must still be like-kind to the relinquished property.  For example, if the relinquished property was real estate with a value of $1,000,000 and the replacement property was real estate with a value of $850,000 plus incidental property of $150,000, the taxpayer will still have tax to pay (known as “ boot”) because the incidental personal property was not like-kind to the relinquished property.
Description of Replacement Property in IRS 1031 Exchange
The description of replacement property must be unambiguous and specific.  For instance, the identification of “a condominium unit at 123 Main Street, Chicago, IL” would fail due to the specific unit not having been identified.  The actual rules are as follows:

Replacement property is identified only if it is unambiguously described in the written document or agreement.
Real property generally is unambiguously described if it is described by a legal description, street address, or distinguishable name (e.g., the Mayfair Apartment Building).
Personal property generally is unambiguously described if it is described by a specific description of the particular type of property. For example, a truck generally is unambiguously described if it is described by a specific make and model.

1031 Exchange Property to Be Improved or Produced
Oftentimes, the property intended to be acquired by the taxpayer will be in a different physical state at the time it is identified than it will be upon receipt by the taxpayer.  The regulations account for this by requiring the identification for real estate to include the address or legal description of the property plus as much detail as practical about the intended improvements.  In connection with the receipt of property to be improved, even if the described improvements are not completed at the time it is received by the taxpayer, the exchange is valid so long as the actual property received does not differ from what was identified by the taxpayer except for the degree of improvements that have been completed. Personal property is a bit different in this regard and the “production” (improvements) needs to be completed within the 180-day term.
Summary
The ability to defer taxes through a §1031 exchange is a very valuable benefit to taxpayers.  However, to receive this benefit, all the exchange rules must be strictly adhered to.  The rules pertaining to identification and receipt of replacement property must be understood and met in order to comply with the technical requirements of this IRC section.  In fact, the property identification rules are so germane to a proper exchange that there is a question asked of the taxpayer on the exchange reporting form 8824 about compliance with these rules.
 

Updated 2/23/2022.

Understanding the rules for identification in regards to a 1031 Exchange are essential for ensuring you are on track for a valid 1031 Exchange. The rules were established as part of the Tax Reform Act of 1984 and have remained unchanged to date. Let’s review the article below which covers the specific rules for identification, as well as receipt of replacement property.
Why is it Necessary to Identify Replacement Property?
In a typical Internal Revenue Code (IRC) §1031 delayed exchange, commonly known as a 1031 exchange or tax deferred exchange, a taxpayer has 45 days from the date of sale of the relinquished property to identify potential replacement property.  This 45-day window is known as the identification period.  The taxpayer has 180 days (shorter in some circumstances) to acquire one or more of the identified properties, which is known as the exchange period. Property(ies) actually acquired within the 45-day identification period do not have to be specifically identified, however they do count toward the 3-property and 200 percent rules discussed below.
These rules are a direct result of the Starker case where for the first time a taxpayer was found to be able to sell relinquished property on one day and acquire replacement property at a different point in time.  In fact, the Starker case involved a five-year gap between the sale and purchase.  Prior to the decision in the Starker case, it was believed that an exchange had to be simultaneous.  As a result of the open-endedness of this decision, as part of the Tax Reform Act of 1984, Congress added the 45/180 day limitation to the delayed exchange.  These time limitations were a compromise between allowing an exchange to be non-simultaneous while at the same time having some temporal continuity between the sale and the purchase.
What are the Identification and Receipt Rules?
The identification rules in a 1031 exchange include the following:

The 45-day requirement to designate replacement property
The 3-property rule
The 200-percent rule
The 95-percent rule
The incidental property rule
Description of Replacement Property
Property to be produced

The 45-day Identification Rule
The exchange regulations provide “The identification period begins on the date the taxpayer transfers the relinquished property and ends at midnight on the 45th day thereafter.”  The identification must (i) appear in a written document, (ii) signed by the taxpayer and (iii) be delivered to the replacement property seller or any other person that is not a disqualified person who is involved in the exchange.  The custom and practice is for the identification to be delivered to the qualified intermediary, however a written statement in a contract to purchase the replacement property stating that the buyer is identifying the subject property as his replacement would meet the requirements of the identification.  The restriction against providing the notice to a disqualified person is that such a person may be likely to bend the rules a bit based upon the person’s close relation to the taxpayer.  Disqualified persons generally are those who have an agency relationship with the taxpayer.  They include the taxpayer’s employee, attorney, accountant, investment banker and real estate agent if any of those parties provided services during the two-year period prior to the transfer of the relinquished property.  Property identifications made within the 45-day period can be revoked and replaced with new identifications, but only if done so within that the identification period.
The 3-Property Rule
This rule simply states that the replacement property identification can be made for up to “three properties without regard to the fair market values of the properties.”  At one time in the history of §1031 exchanges, there was a requirement to prioritize identified properties.  At those times, if a taxpayer wished to acquire a second identified property, they could not do so unless the first identified property fell through due to circumstances beyond the taxpayer’s control.   Presumably this harsh requirement played a role in the 1991 Treasury Regulations where the 3-Property Rule is found.  By far and away, most taxpayers utilize this rule.
The 200% Percent Rule
The 200-percent rule states the taxpayer may identify: 

“Any number of properties as long as their aggregate fair market value as of the end of the identification period does not exceed 200 percent of the aggregate fair market value of all the relinquished properties as of the date the relinquished properties were transferred by the taxpayer.” 

Another way to state this is that the taxpayer can identify any number of properties and actually close on any number of them if the sum of the market value of all of them does not exceed twice the market value of the relinquished property.  There is some uncertainty of how the market value of these properties is determined.  The listing price? The amount the seller is willing to accept?  The amount that the taxpayer agrees to pay?  The answer is unclear but using the listing price would surely be a safe choice.
The 95% Rule
The 95-percent rule is defined as follows: 

“Any replacement property identified before the end of the identification period and received before the end of the exchange period, but only if the taxpayer receives before the end of the exchange period identified replacement property the fair market value of which is at least 95 percent of the aggregate fair market value of all identified replacement properties.”

As a practical matter, this rule is very hard to adhere to.  Basically, it provides that should the taxpayer have over identified for purpose of the first two rules, the identification can still be considered valid if the taxpayer receives at least 95% in value of what was identified.  For example, if a taxpayer identified four properties or more whose market value exceeds 200% of the value of the relinquished property, to the extent that the taxpayer received 95% of what was “over” identified then the identification is deemed proper.  In the real world it is difficult to imagine this rule being relied upon by a taxpayer.
The Incidental Property Rule in Section 1031
The incidental property rule is defined as follows: 

“Solely for purposes of applying this paragraph (c), property that is incidental to a larger item of property is not treated as property that is separate from the larger item of property. Property is incidental to a larger item of property if – (A) In standard commercial transactions, the property is typically transferred together with the larger item of property, and (B) The aggregate fair market value of all of the incidental property does not exceed 15 percent of the aggregate fair market value of the larger item of property.” 

In other words, if there is some incidental property that typically passes to a buyer in standard commercial transactions for this kind of property sale, to the extent that the value of any such property is less than 15%  of the primary property, the incidental property does not have to be separately identified.
To illustrate this rule the exchange regulations use the example of an apartment building to be acquired for $1,000,000 which includes furniture, laundry machines and other miscellaneous items of personal property whose aggregate value does not exceed $150,000.  In this example, those various items of personal property are not required to be separately identified nor does that property count against the 3-Property Rule.  Be aware however that this rule only applies to identification and not to making sure that replacement property must still be like-kind to the relinquished property.  For example, if the relinquished property was real estate with a value of $1,000,000 and the replacement property was real estate with a value of $850,000 plus incidental property of $150,000, the taxpayer will still have tax to pay (known as “ boot”) because the incidental personal property was not like-kind to the relinquished property.
Description of Replacement Property in IRS 1031 Exchange
The description of replacement property must be unambiguous and specific.  For instance, the identification of “a condominium unit at 123 Main Street, Chicago, IL” would fail due to the specific unit not having been identified.  The actual rules are as follows:

Replacement property is identified only if it is unambiguously described in the written document or agreement.
Real property generally is unambiguously described if it is described by a legal description, street address, or distinguishable name (e.g., the Mayfair Apartment Building).
Personal property generally is unambiguously described if it is described by a specific description of the particular type of property. For example, a truck generally is unambiguously described if it is described by a specific make and model.

1031 Exchange Property to Be Improved or Produced
Oftentimes, the property intended to be acquired by the taxpayer will be in a different physical state at the time it is identified than it will be upon receipt by the taxpayer.  The regulations account for this by requiring the identification for real estate to include the address or legal description of the property plus as much detail as practical about the intended improvements.  In connection with the receipt of property to be improved, even if the described improvements are not completed at the time it is received by the taxpayer, the exchange is valid so long as the actual property received does not differ from what was identified by the taxpayer except for the degree of improvements that have been completed. Personal property is a bit different in this regard and the “production” (improvements) needs to be completed within the 180-day term.
Summary
The ability to defer taxes through a §1031 exchange is a very valuable benefit to taxpayers.  However, to receive this benefit, all the exchange rules must be strictly adhered to.  The rules pertaining to identification and receipt of replacement property must be understood and met in order to comply with the technical requirements of this IRC section.  In fact, the property identification rules are so germane to a proper exchange that there is a question asked of the taxpayer on the exchange reporting form 8824 about compliance with these rules.
 

Updated 2/23/2022.

It’s been a number of years since we visited this article and while the core of 1031 exchanges have not changed, it is important to remember the foundation to ensure compliance. Two separate deadlines drive the 1031 exchange process and they are covered at length below. Another important concept discussed is how the 180-day exchange period which can be affected by the due date of the taxpayers return, so be sure to take special consideration of that as you read through the article below. 
Despite working with like-kind exchanges (LKEs) for a number of years, we never tire of discussing the basics. That’s because, despite structural intricacies, LKEs are, at their core, deadline and document driven. It’s these basics that build a strong foundation for understanding LKEs as they increase in complexity. For this month’s LKE tip, let’s consider some basics and focus on exchange deadlines.
LKEs generally consist of two separate deadlines:

The 45-Day Identification Deadline and
the 180-Day Completion Deadline.

The 45-day window is frequently referred to as the “identification period,” while the 180-day window is often called the “exchange period.” Note that both deadlines are triggered on the same date and run concurrently.
In a standard Delayed Exchange (taxpayer sells first and buys at a later date), both deadlines are triggered on the date ownership of the relinquished property is transferred. Under the standard Reverse Exchange structure (buy first, sell later), both deadlines are triggered on the initial ownership transfer date of the replacement property. However, for both types, the counting of days doesn’t actually begin until the day after ownership transfer occurs.
In order to complete a valid 1031 exchange, the replacement property must be both:

properly identified by midnight on day 45 and
received by midnight on day 180.

A couple other things to note:

Both the 45- and 180-day deadlines include all calendar days, including weekends and holidays.
The deadlines are absolute with extensions only allowed for:

Presidentially declared disasters
Terrorist or military actions
Taxpayers serving in combat zones

Furthermore, as we approach the end of the calendar tax year, it is vital to fully understand the 180-day deadline. The regulations clearly specify the exchange period as:

“..the date the taxpayer transfers the relinquished property and ends at midnight on the earlier of the 180th day thereafter or the due date (including extensions) of the taxpayer’s return of the tax imposed by chapter 1 of subtitle A of the Code for the taxable year in which the transfer of the relinquished property occurs.”

In short, if you are participating in a like-kind exchange, be sure to review the due date of your tax return and contemplate the need to apply for an extension of time to file. Otherwise, you might find yourself with an unexpectedly short exchange period.
 
Updated 2.07.2022.