If you are familiar with the 1031 exchange, you are probably aware that Section 1031 of the Internal Revenue Code allows investors three options for selecting replacement properties with their exchange. Yet, we find that many exchangers aren’t sure which approach is best for them, or they don’t fully understand the requirements of each option.

You Have Options

As a reminder, 1031 exchange rules require you to identify your replacement property or properties within 45 days of closing on your relinquished property. The three approaches to replacement property identification are:

• 3 Property Rule: This option allows you to identify up to three replacement properties for your 1031 exchange. This is a popular choice for many because real estate deals can fall through, and exchangers who select only one replacement property can find themselves with a failed exchange if they are unable to close on their selected property.
• 200% Rule: If you would like to acquire multiple properties to create a more diversified real estate portfolio, the 200% rule option is a good choice. This rule allows you to identify as many properties as you’d like as long as their combined value does not exceed 200% of the sale price of your relinquished property. This rule is most commonly used by investors who would like to identify four or more properties and who are likely to select Delaware Statutory Trust (DST) investments. 
• 95% Rule: This rule is an exception to the 200% rule in that it allows you to identify unlimited properties in excess of 200% or the sale price of your relinquished properties as long as at least 95% of the value of those properties is acquired. The key with this rule is if you don’t close on at least 95% of the value of the identified properties, the 1031 exchange will be nullified.

A Closer Look at the 200% Rule

Using the 200% rule when identifying replacement properties for your 1031 exchange can be beneficial, as it enables you to grow your returns from an expanded real estate portfolio over time. The 200% rule allows you to broaden your search for replacement properties among a larger pool of potential opportunities. 

Advantages of the 200% rule include:

• You can identify an unlimited number of replacement properties.
• The total cost of the replacement properties does not have to exceed 200% of the original property’s value.
• You have more options and flexibility when searching for your replacement properties.

Factors to consider when evaluating the 200% rule option are 

it requires more planning and coordination to ensure you don’t go over the 200% limit, and you might not be able to find enough replacement properties that fit within the 200% limit.

200% Rule in Action - The Power of Diversifying with DSTs

As mentioned, the 200% rule is most popular with investors using a 1031 exchange to rid themselves of the daily hassles and management responsibilities of direct property ownership and instead own a fractional passive interest in professionally managed Delaware Statutory Trusts (DSTs). A DST enables you to create a diversified portfolio or institutional-quality investment property by identifying multiple properties and different DST sponsors.

Since the minimum investment for most DSTs is $100,000, you could select and acquire an interest in many DSTs with $1 million in proceeds from your relinquished property. This hypothetical example illustrates how:

• $200,000 in a medical office DST in Los Angeles
• $100,000 in a multifamily apartment DST in Kansas City
• $200,000 in a self-storage DST in Jacksonville
• $300,000 in a multifamily apartment DST Colorado Springs
• $100,000 in a student housing DST in Charlotte
• $100,000 in a mixed-used apartment DST in Phoenix

As you can see, identifying a broad range of replacement properties for your 1031 exchange using the 200% rule is a helpful method for diversifying your real estate holdings by asset class and geography throughout the U.S. 

Conclusion

The 1031 exchange process involves many moving parts, and the replacement property identification requirement is one of the most vital. Understanding your options for selecting replacement properties and recognizing the potential advantages of using the 200% rule to identify a diversified group of replacement properties, may help you take your investment properties to the next level. 

If you’re considering a 1031 exchange, our team at Fortitude Investment Group is here to guide you through every step of the process. You can get started by contacting our team to schedule a no-cost consultation. 

Because investor situations and objectives vary this information is not intended to indicate suitability for any particular investor.

This is for informational purposes only, does not constitute individual investment advice, and should not be relied upon as tax or legal advice. Please consult the appropriate professional regarding your individual circumstance.

There are material risks associated with investing in private placements, DST properties and real estate securities including illiquidity, general market conditions, interest rate risks, financing risks, potentially adverse tax consequences, general economic risks, development risks, and potential loss of the entire investment principal.

DST 1031 properties are only available to accredited investors (typically defined as having a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last two years; or have an active Series 7, Series 82, or Series 65. Individuals holding a Series 66 do not fall under this definition). If you are unsure if you are an accredited investor and/or an accredited entity, please verify with your CPA and Attorney.

Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Advisory services offered through Concorde Asset Management, LLC (CAM), an SEC registered investment adviser. Insurance products offered through Concorde Insurance Agency, Inc. (CIA). Fortitude Investment Group, LLC is independent of CIS, CAM and CIA. bd-ld-a-494-4-2023