When researching 1031 exchanges, you may get the impression that you’re only allowed to exchange one property for another. Rules like the equal-or-greater-value requirement and identification deadlines make the purchase of one property the easiest and most sensible route to take. However, some investors have unique needs, especially in terms of diversification. If you’re one of these investors, you may have wondered whether you can exchange one property for two in these transactions.
The short answer is yes, and this practice is exceedingly common. However, exchanging more than one property has its own set of rules, advantages, and considerations that you must understand thoroughly before committing to this strategy.
Refresher on 1031 Exchanges
In a 1031 exchange, the IRS allows you to “swap” like-kind properties and defer capital gains taxes. The interpretation of like-kind is broad, but the simplest description is that both assets must have been held for investment or business use. There are also other rules, such as deadlines, identification protocols, and value requirements. However, the service doesn’t provide a specific number of properties you can exchange for the relinquished asset. As such, in theory, you can exchange into as many as you want, not just two.
Nevertheless, there are existing limits that help regulate how many assets you can acquire. These provide a framework that helps ensure compliance and strategic tax deferral.
Split Exchanges
1031 exchange multiple replacement properties are allowed, and investing in two assets is among the most common strategies. This is also called the split exchange, and it’s fully permissible under IRS guidelines.
For example, a split exchange can involve a landlord selling one apartment complex and using the proceeds to purchase two smaller multi-family properties. This split exchange can be helpful for those who want fewer management burdens or those who see growth or stability in this asset class.
Split 1031 Exchange Rules
What are the specific regulations that create the framework for multiple exchanges? Here’s what you need to know.
Identification Rules
The most applicable regulations for split or multiple exchanges are the 1031 exchange identification rules. In a classic exchange, you are given 45 days to identify three possible replacement properties. Following this rule, you are only allowed to acquire one of these properties.
- 200% Rule: For those planning to acquire more than one asset, the 200% rule applies. Under this rule, you can identify an unlimited number of properties so long as the cumulative fair market value is under 200% of the proceeds from your relinquished asset.
- 95% Rule: Past 200%, the next applicable rule is the 95% rule. You can still identify an unlimited number of properties beyond 200% of the cumulative value of your relinquished property, but you’re required to acquire assets that amount to at least 95% of the total identified value. This rule is seldom applicable, since investors must shell out relatively large amounts of capital to satisfy this rule.
Purchase Deadlines
All replacement properties must be acquired within 180 days of the sale of the original property. This timeline does not reset for each purchase. The clock applies to the entire exchange, making this fact a major consideration due to the lengthy process of acquiring like-kind properties. Missing this deadline will mean the loss of your tax-deferral benefits.
Equal or Greater Value
Finally, there’s the fact that the properties you acquire must have a value that’s equal to or greater than the relinquished asset. This also applies to debt. Otherwise, any leftover cash or mortgage debt will be considered boot and is taxable.
Why Investing in Several Properties Is Advantageous
Split exchanges are one of the popular 1031 exchange diversification strategies. Thanks to such approaches, investors can gain access to new asset classes or sectors, gain income from more than one source, and enhance diversification overall.
When strategies like Delaware Statutory Trusts (DSTs) are implemented, diversification further improves. Passive income, especially for investors who no longer want direct involvement in their assets, also becomes possible through DSTs.
Wrapping Up: Can You Buy Two Properties in a 1031 Exchange?
Yes. The IRS allows split exchanges, and many investors take this route to enhance diversification, enter new asset classes, and mitigate risk. As long as the exchange follows the core requirements, such as value rules and deadlines, then the number of properties doesn’t matter as much. The important thing is to implement careful planning, strict adherence to identification and timing rules, and working with experienced professionals, such as qualified intermediaries and tax advisors.
Sources:
https://www.delawareinc.com/blog/what-is-a-delaware-statutory-trust/
https://www.americanbar.org/groups/real_property_trust_estate/resources/real-estate/1031-exchange/
https://www.investopedia.com/financial-edge/0110/10-things-to-know-about-1031-exchanges.aspx
