Last updated on June 24th, 2021 at 12:06 pm
A 1031 exchange isn’t always a simple 1-for-1 trade. You can also do a 1031 exchange with multiple properties.
The exchange with multiple properties can work in two ways:
- Relinquishing one property and replacing it with multiple properties.
- Relinquishing multiple properties and replacing them with a single property.
It’s a powerful variation on the simple 1-for-1 1031 exchange. It radically increases your investment possibilities — and your potential tax deferral advantages.
But a 1031 exchange with multiple properties is also much more complex than a conventional 1031 exchange. If you’re undertaking a 1031 exchange with multiple properties, it’s best to partner with an experienced qualified intermediary who can help you navigate the process.
🏘️ Contact us today and we’ll put you in touch with vetted 1031 professionals who’ll help you achieve your investment goals.
1031 exchange of one property for multiple properties
The most common scenario for a 1031 exchange involving multiple properties arises when an investor sells one valuable property and trades up to multiple rental properties. Markets that have seen high appreciation over the past decade or two — especially California, Hawaii, New York, and Washington — have seen a rise in these exchanges.
Here’s how a 1031 exchange with one property for two (or more) might work.
Example: 1031 exchange one property into multiple properties
An investor owns an investment property in Seattle. Values have boomed in the city in recent years, going from a median value of around $360,000 in 2006 to just over $816,000 in 2021.
This investor has rented this property for the last decade. While the cash flow remains positive, the investor is approaching retirement age and wants to increase his income.
Instead of selling the Seattle property, and paying capital gains taxes on the profit, he decides to do a 1031 exchange that turns his one property into two.
After selling his Seattle property for $800,000, the investor identifies two rental properties in Charlotte, North Carolina (median home value: just under $300,000) that he’d like to acquire through his qualified intermediary.
While this investor has around $200,000 in sale proceeds left over — in the context of a 1031 exchange, this is called “boot”– he has several options. He could:
- Find a third investment property valued at $200,000.
- Use the $200,000 to perform renovations and improvements on the two properties, via a 1031 improvement exchange.
- Pull the cash out and pay capital gains (and depreciation recapture) taxes on it.
Once the 1031 exchange with multiple properties is concluded, the investor has turned one property into two and some taxable cash, or even three new properties.
So why would an investor would want to do this?
The benefits of relinquishing one property for multiple replacement properties
|✅ Benefit||📝 Explanation|
|Risk reduction||Owning a single investment property is like having all your eggs in one basket. If something happens to it, you’re in trouble. Owning multiple properties spreads the risk around.|
|Increased cash flow||You can only make so much rent from a single property, even if it’s in a very expensive market. Exchanging one property for multiple lower-priced rentals can multiply your cash flow.|
|Bubble avoidance||No one knows they’re in a bubble until it bursts. Still, the hotter the market, the more likely it could be a bubble. Getting out of a booming market, and into multiple cooler markets protects you from the painful aftermath of a market correction.|
1031 exchange of multiple properties for a single property
The 1031 exchange with multiple properties can also be used to consolidate several smaller investment properties into one high-value investment property.
Example: 1031 exchange multiple relinquished properties into one property
An investor lives in Los Angeles and owns single-family homes in Culver City, Costa Mesa, and San Diego, each valued at around $500,000. Each of these rental properties is handled by a different property management company.
The properties are miles apart and, with awful Southern California traffic, it takes hours to check on the properties.
This investor learns of a commercial retail property in downtown Los Angeles that’s selling for $1.5 million. With commercial rents rising in the area — and a location that’s only minutes from the investor’s home — trading the three single-family homes for this property through a 1031 exchange would reduce maintenance costs, save the investor hours of travel time every week, and maybe increase cash flow.
Once the three single-family properties have been vacated, the investor uses a 1031 exchange to sell the three homes and flip the sale proceeds, while deferring capital gains, into the commercial property.
The benefits of relinquishing multiple properties and consolidating into one replacement property
|✅ Benefit||📝 Explanation|
|Savings on management fees||The average property manager charges 10% of rents collected. That’s a steep price to pay, especially when you’re paying it to multiple managers. Eliminating or reducing this cost gives your cash flow a bump.|
|Time saved||Owning, managing, and monitoring multiple rental properties takes a lot of time, which could be spent on personal pursuits or your next investment.|
|Moving into a different property type||Residential, single-family rentals are a common way for real estate investors to start out, but many want to graduate to other real estate sectors. A 1031 exchange can be your ticket out of residential properties and into commercial, retail, or office properties.|
The rules of a 1031 exchange with multiple properties
Executing a 1031 exchange with multiple properties is a little more complicated than doing a 1-for-1 trade. But the fundamentals are the same.
Let’s look at three basic rules of the 1031 exchange and how they apply to a 1031 exchange with multiple properties.
The three property rule in a 1031 exchange with multiple properties
In a conventional 1031 exchange, the investor has a 45-day identification period to identify up to three potential replacement properties.
The investor doesn’t have to buy all of these properties, but the addresses of three potential properties have to be turned into the qualified intermediary by the close of the 45th day for the 1031 exchange to be valid.
However, what if you’re selling a single property and you want to trade up for multiple properties?
You may be looking to buy more than three replacement properties, or you may want to draw your eventual replacement properties from a pool larger than just three properties.
That’s where the 200% rule comes in.
The 200% rule in a 1031 exchange with multiple properties
If you’re doing a 1031 exchange with multiple replacement properties, you’re allowed to identify more than three replacement properties as long as the total value of your potential replacements doesn’t exceed 200% of the sale price of your relinquished property.
For example, if you’re selling a $1 million property, you can identify more than three replacement properties — as long as the total aggregate value of the properties isn’t more than $2 million.
But there’s more.
The 95% rule in a 1031 exchange with multiple properties
If you use the 200% rule to identify more than three replacement properties, you must end up closing on at least 95% of the total value within the 180 day exchange period for the exchange to be valid.
For example, let’s say you’re selling a $1 million property, and you want to obtain multiple rental properties, through a 1031 exchange, with the proceeds.
You invoke the 200% rule to identify more than three replacement properties within the 45-day identification period. Let’s say you end up identifying five properties with a total value of $1.8 million.
In this situation, you must close on at least 95% of $1.8 million, or $1,710,000 in value, for the 1031 exchange to be valid. If you close on less than that, you won’t get any of the tax deferral advantages of the exchange.
Timeline concerns in a 1031 exchange with multiple properties
If you’re selling multiple properties with the idea of using a 1031 exchange to reinvest in a single property, the 180-day exchange period and the 45-day identification period are both triggered when the first of your multiple properties are sold.
With that in mind, you’ll want to carefully choreograph your property sales to make sure they all fall within the required period. Failing to identify your replacement properties within the 45-day period, or failing to close on your replacement properties within 180 days, can imperil your tax deferral benefits.
🏘️ NEED HELP WITH A 1031 EXCHANGE WITH MULTIPLE PROPERTIES? Of course, those tax deferral benefits are the main reason for doing a 1031 exchange. With so much at stake, it makes sense to partner with a seasoned, knowledgeable expert who knows how to navigate these confusing rules and timelines.
Contact us and we’ll refer you to a vetted, elite 1031 exchange expert who can answer all your questions.
What role can a Delaware Statutory Trust play in a 1031 exchange with multiple properties?
A Delaware Statutory Trust (DST) allows you to buy into a portion of a large commercial investment. You can eventually sell that fractional share just as you would a conventional property.
This kind of investment vehicle can come in handy if you’re selling multiple investment properties but can’t find — or aren’t interested in — a single replacement property.
Using a 1031 exchange, you could sell your multiple investment properties and reinvest the full proceeds in a fractional interest in a DST. You’ll be able to fully defer capital gains, and you’ve flipped multiple properties into a low-maintenance investment.
What role can an NNN lease play in a 1031 exchange with multiple properties?
An NNN lease means the tenant is responsible for repairs, maintenance, utilities, etc.
This type of lease can come in handy if you want to trade multiple properties for a single commercial property, but you don’t want to deal with all the accompanying maintenance and expense.
For example, you see an opportunity to use a 1031 exchange to sell multiple residential rentals and reinvest the proceeds in a downtown office building. But a big office building comes with a lot of expenses — utilities, upkeep, insurance, staffing.
An NNN lease puts those responsibilities on the tenant, so you can enjoy more of a hands-off ownership.
Keep in mind that, with NNN leases, tenants typically pay lower rent to offset their expenses.