Can I Buy Multiple Properties in a 1031 Exchange?
Diversify your investments by exchanging one property for multiple. This guide explains the financial and procedural rules for a fully tax-deferred transaction.
A 1031 exchange allows real estate investors to defer capital gains taxes when selling an investment property by reinvesting the proceeds into a new, like-kind asset. A common question is whether an investor can sell one property and purchase several new ones. The answer is yes, allowing an investor to diversify or expand a portfolio by exchanging one property for multiple replacements. This strategy requires careful adherence to Internal Revenue Code Section 1031 rules, which ensure the transaction is a continuous investment rather than a simple sale and repurchase.
The Identification Rules for Multiple Properties
When acquiring more than one property in a 1031 exchange, an investor must follow one of three specific identification rules. Only one of these rules needs to be met for the exchange to be valid.
The first is the Three-Property Rule. This rule allows an investor to identify up to three potential replacement properties, regardless of their fair market value. For instance, if an investor sells a property for $1 million, they can identify three potential replacement properties. The investor does not have to acquire all three; they can purchase one, two, or all three of the identified assets.
A second option is the 200% Rule, which applies if an investor identifies more than three properties. Under this rule, the total fair market value of all identified properties cannot exceed 200% of the value of the property sold. For example, if the relinquished property sold for $1 million, the investor could identify four or more properties, but their total value could not surpass $2 million.
The final option is the 95% Rule, which is an exception if an investor fails to meet the first two rules. This rule requires the investor to acquire and close on at least 95% of the fair market value of all properties identified. If an investor identifies properties valued at $2.5 million after selling a $1 million property, they must purchase properties worth at least $2.375 million. This rule is less commonly used as it presents a higher risk if any intended purchases fall through.
The Identification and Acquisition Process
The timeline for a 1031 exchange begins when the original property sale closes. An investor has a 45-day identification period to formally name the potential replacement properties they intend to purchase. This 45-day window includes all calendar days, weekends, and holidays.
The identification must be a formal, written declaration signed by the investor and delivered to their Qualified Intermediary. The notice must unambiguously describe the properties, which is satisfied by providing a legal description or a street address.
The total timeframe for completing the exchange is 180 calendar days from the closing of the relinquished property. The 45-day identification period runs concurrently with this 180-day acquisition period. This means that after the 45th day, the investor cannot change their identified properties and must work to close on one or more of them before the 180-day deadline expires.
Meeting Value Requirements and Handling Boot
To achieve full tax deferral in a 1031 exchange, an investor must satisfy two value requirements. First, the total purchase price of all acquired replacement properties must be equal to or greater than the net selling price of the relinquished property. Second, the investor must carry over the same amount of debt into the new properties as they had on the property they sold.
Failing to meet these conditions results in “boot,” which is non-like-kind property received in the exchange that is generally taxable. The first form is cash boot, which occurs if the total value of the acquired properties is less than the value of the property sold. If an investor sells a property for $1 million but only purchases new properties for a combined total of $900,000, the leftover $100,000 in cash proceeds is considered cash boot.
The other common type is mortgage boot, also known as debt relief. This happens when the total mortgage debt on the new replacement properties is less than the mortgage that was paid off on the relinquished property. For example, if the sold property had a $400,000 mortgage, but the combined mortgages on the new properties only total $350,000, the $50,000 difference is mortgage boot.
An investor can offset mortgage boot by adding an equivalent amount of their own cash to the purchase, but they cannot offset cash boot by taking on more debt.