The Three Property Rule is defined under IRC Section 1031, which states that an exchanger or taxpayer executing a delayed exchange has 45 calendar days from the closing date of the sale of their relinquished property to formally identify a replacement property or properties.
Under the Three Property Rule the exchanger may identify up to three properties, regardless of value, as long as he or she acquires one of the three as the replacement property within the 180-day exchange period.
Using the Three Property Rule, an investor doesn't have to worry about the identified properties' fair market value. If, on the other hand, the investor wants to identify more than three properties, the Three Property Rule no longer applies, and they will slip into the 200% Rule. This rule states that the identified properties' aggregate value can't exceed more than 200% of the relinquished property's value.
When you’re trying to trade up in value, the Three Property Rule is more applicable. If you are trying to diversify across many properties (more than three), the 200% Rule comes into play.
You can still diversify by using the Three Property Rule. The Three Property Rule doesn’t mean you have to exchange into just one property. You can exchange into up to three properties. These properties can all have a much higher value than the relinquished property as well. For example, if the relinquished property’s value is $500,000, you can exchange into three $10 million properties. Just keep in mind that it is more advantageous to exchange into properties that are of equal or greater value.
The taxpayer can revoke a property from their list of identified properties. There is no limit on how many times they can add or remove properties from the list, just as long as the list is finalized within the 45-day timeframe.