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How to Exchange Two Properties For One in A 1031 Exchange

September 15, 2023

Did you know you can exchange multiple properties for one provided you comply with the IRS requirements?

That being said, exchanging two properties for one is a complex process that leaves no room for mistakes. In order to do so, you’ll need to understand the rules and steps to take to ensure a successful exchange.

This article explores everything you need to know about of exchanging multiple properties for one. The requirements, potential challenges, and common mistakes to avoid.

What is a 1031 Exchange?

What is a 1031 Exchange?

According to section 1031(a) of the U.S internal revenue code, no gain or loss shall be recognized on the exchange of real property held for productive use in a trade, business, or investment. 1031 exchange requires that such real property is exchanged for replacement properties of like kind for productive use in business or investment.

This provision allows taxpayers to swap an investment property without incurring capital gains taxes, allowing the investor to reinvest the proceeds into replacement properties of equal or greater value. By deferring capital gain tax, you have more funds to grow your real estate investment or upgrade your business properties.

Can I Exchange 2 Properties For 1?

Yes! You can relinquish two properties for a single replacement property. In fact, the number of relinquished properties you can exchange is unlimited as long as the value of the replacement property is equal to or greater than the combined values of the relinquished properties.

Can I Exchange 2 Properties For 1?

Exchanging two properties for one is a useful way for investors consolidate their assets. Consolidating assets has several pros and cons. We’ve listed the two main benefits below:

Ease in Management

Having multiple properties, especially in different locations, may present complex management logistics – property maintenance, performance tracking, and other tasks could be challenging. Consolidation simplifies management as it reduces the stress and costs of managing multiple properties.

Better Assets

You may give up two rental properties to acquire either a larger property, a property situated in a better market, or a property with a higher growth potential. This may position you for a better capital appreciation or resale value in the future.

Requirements for a Valid 1031 Exchange if Multiple Properties for 1

The 1031 exchange is a complex process and requires compliance with the relevant rules for a successful tax-deferred exchange. Below are the requirements for a valid 1031 exchange.

Requirements for a Valid 1031 Exchange if Multiple Properties for 1

Properties Must be Like-kind

According to the Internal Revenue Code (IRC), two properties are like-kind if they’re similar in nature irrespective of quality or size. Also, both the relinquished and replacement properties must be held for investment or business purposes. In other words, personal residence does not qualify for such an exchange.

Note that neither of the like-kind properties must be outside the U.S. Otherwise, the exchange won’t qualify for deferral of capital gain taxes. Examples of like-kind properties include: 

  • Apartment building for a shopping center
  • Office building for a warehouse
  • Raw land for a shopping center or rental properties.

Equal or greater Value Replacement Property Rule

The value of the replacement property must be equal or greater than the value of the relinquished property. You have the opportunity to identify at most three properties regardless of their value, or more than three properties whose total value does not exceed 200% of the value of the relinquished property. This is known as the 200% rule.

Also, you can identify an unlimited number of properties whose combined value is more than 200% of the relinquished property, as long as you acquire 95% of the replacement properties. For example, if you sell a shopping center for $1 million, you can identify 15 apartment buildings collectively worth $7 million as long as you acquire $6.65 million of the combined value.

Specified Timeline

The investor has a maximum of 45 days to identify a replacement property and 180 days to purchase the property. The 45-day identification period runs simultaneously with the 180-day closing period. Hence, you have 135 days after the expiration of the identification period to close the exchange.

Note that the 45-day and 180-day timelines are calculated in calendar days – Saturdays and Sundays inclusive. Failure to complete the process within these timelines results in an unsuccessful 1031 exchange, leaving you liable to capital gains tax.

The Process of Exchanging 2 for 1 in 1031 Exchange

The Process of Exchanging 2 for 1 in 1031 Exchange

Identify potential replacement properties

Before selling multiple properties for one, you should already be on the lookout for a suitable replacement property. This helps you avoid the undue pressure of the strict timelines. A seller might increase the price of their property if they learn that you’re looking for a replacement property within a tight deadline.

Use a Qualified Intermediary (QI)

A qualified intermediary (QI) is an entity that facilitates the 1031 exchange to help you stay compliant with the IRS 1031 exchange guidelines. The QI performs three major roles:

  • Holds in escrow the sale proceeds of the relinquished property since you’re not allowed to be in possession of the fund throughout the exchange period.
  • Completes all the relevant paperwork required for selling multiple properties and identification of replacement properties including the 1031 exchange contracts.
  • Transfer the replacement property to the exchanger once all the requirements have been fulfilled.

It’s crucial to choose a registered and competent QI to ensure a smooth and successful exchange. Here at the Universal Pacific 1031 Exchange, we have licensed CPA professionals across the states to help you with your 1031 exchange needs. Our 1031 intermediary services include: 

Close the two relinquished properties.

List the relinquished properties on the real estate market and close the sale once you find a suitable buyer. Ensure you involve the QI in this process so you won’t be in possession of the proceeds. The proceeds go directly to the QI who would hold the funds until you close the purchase of a new property.

Secure the New Property and Complete the Exchange

If you have identified the right property in compliance with the applicable 1031 rules, it’s time to close the deal. At this point, the QI will transfer your funds to the seller and you have the title to the replacement property.

Potential Challenges and Considerations

Potential Challenges and Considerations

  • Balancing equity when moving from two properties to one

To defer capital gains taxes, you must reinvest all the proceeds of the sale of your relinquished property into acquiring the desired replacement property. If the new property costs less, you’ll have a remaining fund. This remainder – whether in the form of cash or other asset – is called boot and is subject to capital gains taxes.

  • Financing considerations

Swapping multiple properties through 1031 exchange demands that you’re financially ready as you have 180 days to identify and close the exchange.

For example, if you identify several properties that are more than 2x of the total value of your old properties but you’re unable to acquire 95% due to lack of access to funds, the 1031 exchange may be unsuccessful.

  • The risk of not meeting the strict 1031 timelines

Finding a like-kind property within a 45-day timeline can be challenging. Again, the replacement must not cost less than the multiple properties relinquished. Failure to meet any of the stipulated deadlines automatically results in an unsuccessful 1031 exchange, meaning you’ll not be able to defer capital gains taxes. 

Common Mistakes to Avoid in 1031 Exchange of 2 Properties for 1

Failing to meet identification and closing deadlines.

Adhering to the identification and closing timelines is crucial to ensure a successful 1031 exchange involving multiple properties. Plan in advance so you have enough time to identify the potential replacement.

Also, get your finances ready and make provisions for uncertainties to avoid missing the closing deadlines. Again, work with a qualified intermediary to guide you through the process and ensure you meet all deadlines.

Choosing a non-qualified intermediary

The role of QI in the 1031 exchange is highly essential and you may not afford the risks of choosing a non-qualified or inexperienced intermediary. Make thorough research and ensure the QI is registered with the IRS. The Universal Pacific 1031 Exchange is a qualified intermediary with a solid track record of hassle-free 1031 exchange services.

Not matching or exceeding the value of the relinquished properties

Boots are subject to capital gains tax, which is why you should consider the value of the potential replacement property before you make the swap. You may also need the help of a 1031 exchange advisor or a tax consultant to walk you through this process.

Benefits of Consulting Professionals

The 1031 exchange is a complex process with many pitfalls – a little mistake at any step could result in an unsuccessful exchange. So, it’s important to seek the help of professionals for proper guidance. The services of professionals like real estate advisors, tax consultants, and attorneys help you ensure a smooth and compliant exchange process. For example,

  • A real estate advisor helps you find a suitable replacement property tailored to your investment goals, saving the time and effort of a property search. They also provide insights into the property type and value, as well as the benefits and risks of specific locations.
  • A tax consultant helps you understand the tax implications of every stage of the process as they’re well-versed in the tax laws and regulations surrounding the 1031 exchange. They also help you identify a property that aligns with the IRS requirements, helping you make informed decisions.
  • An attorney will help you cover all the legal aspects of the exchange and also review the 1031 exchange contract to ensure compliance with the governing laws.

Conclusion

Exchanging two properties for one helps you achieve a tax-deferred consolidation of assets which can simplify asset management and maintenance. However, it comes with challenges and pitfalls, which you can easily navigate with the help of professionals. Understanding and adhering to the rules of a 1031 exchange will help you achieve a successful exchange.

Are you looking for a registered qualified intermediary to facilitate your 1031 exchange? Here at Universal Pacific 1031 Exchange, we are experienced in handling the complexities of 1031 exchange process and can help you navigate the process. Contact us now for a free consultation.

About The Author

Michael Bergman, CPA
Michael Bergman is a California licensed CPA and Real Estate Broker with over 32 years of experience in commercial real estate. Specializing in 1031 tax-deferred exchanges and financial oversight, his expertise is invaluable for complex real estate transactions. Michael’s unique blend of financial acumen and real estate knowledge positions him as a trusted advisor in the industry, offering sound advice and strategic insights for successful property management and investment.

Don’t let taxes hinder your property investment decisions. Connect with us today for a free, no-obligation 1031 exchange consultation. Let us help you navigate the process with ease.