1031 Exchange 45-Day Rule Extension: How it Works and What to Consider

A 1031 Exchange has many rules, and getting any of them wrong can mean cancellation of the exchange. If that happens, the investor will get their money back, but it will come with a hefty tax bill since gains on the relinquished property are now taxable.

One of the most important rules in the 1031 Exchange investors must get right is the 45-day rule. It’s the first exchange deadline that investors will need to meet. However, because of severe storms in California on January 8, 2023, the 45-day deadline is being extended. Let’s go over what that means for California investors.

How the 45-day Rule Works

The 45-day rule is the identification period in a 1031 exchange. It gives investors 45 days to identify up to three properties that can be used as replacement properties in the exchange.

There is also the 180-day deadline, which covers the entire exchange. It starts on the day that the relinquished property is closed.

Here are a few things that occur during the first 45 days:

• Identify three properties if possible. These properties can’t be changed after day 45.
• Must close on at least one of the properties. If you don’t have any properties during the 45 days, the exchange is canceled, and your funds are sent back to you on day 46. Gains are now taxable.

If a property you identify falls through, you can re-up/replace it with another property. If something happens and a property falls through on day 60, your funds are tied up until day 181. In other words, you have to wait for the full exchange timeline to play out. Those gains will be taxed.

It can become a more complex scenario if your exchange is canceled but straddles two calendar years. It’s best to set up the exchange so it finalizes within the same calendar year.

Note that the selection of three properties is not a limit with an exception. For example, if you identify four properties, their value can’t exceed 200% of the relinquished property’s value. Otherwise, you can land in the 95% rule. The 95% rule requires that you close on at least 95% of everything you’ve identified, or the exchange is invalidated.

• Due diligence on the property.
• Lender orders appraisal.
• Close within 45 days
• Relinquished property funds go to QI.

 

45-Day Rule Extension

Due to severe weather that occurred in California on January 8, 2023, residents of specific areas of California will receive an extension to the 45-day rule. The extension applies to those who started a 1031 exchange between November 24, 2022 and January 8, 2023.

The extension applies May 15, 2023, or 120 days after the original 45-day deadline date, whichever is later. Tax filers may need to file tax return extensions so that the exchange extension can be included. 

Note that the extension does not apply to persons requiring more time and not affected by the weather event.

Further information on the extension can be found here: https://www.irs.gov/newsroom/irs-announces-tax-relief-for-victims-of-severe-winter-storms-flooding-and-mudslides-in-california.

Given the complexity of a 1031 exchange and the IRS tax code, it’s best to work with an experienced California realtor and accountant who can help file tax return extensions if needed.