What Is the 95 Percent Rule in a 1031 Exchange?
The 95 percent rule is one of the replacement property identification rules in a delayed 1031 exchange. It can allow an investor to identify many properties, but it is risky because the investor generally must acquire nearly all of the total value identified.
95 Percent Rule: The Short Answer
The 95 percent rule is one of the lesser-used replacement property identification rules in a delayed 1031 exchange.
It may allow an investor to identify any number of replacement properties, even if the total value exceeds the 200% rule limit.
The catch is that the investor generally must receive replacement property worth at least 95% of the total fair market value of all identified replacement properties.
Because that is difficult to satisfy, most investors do not rely on this rule unless they have strong confidence that nearly all identified properties will close.
Why This Identification Rule Exists
A delayed 1031 exchange gives investors a limited time to identify replacement property.
The three property rule and 200% rule are the two most common identification methods.
The 95 percent rule exists as another path, but it comes with a much stricter closing requirement.
Simple Example
This example shows why this identification method can be risky.
Property Sold
An investor sells a relinquished property and starts a delayed 1031 exchange.
Many Properties Identified
The investor identifies several replacement properties with a total fair market value of $1,000,000.
95% Requirement
To satisfy the rule, the investor generally must acquire at least $950,000 worth of the identified properties.
Closing Risk
If enough identified properties fail to close, the exchange may be at risk.
Why This Rule Is Risky
This identification method sounds flexible at first because it can allow an investor to identify many properties.
But that flexibility comes with a difficult requirement.
If the investor identifies too much property and then fails to acquire at least 95% of the total identified value, the exchange may fail.
How It Compares to the Three Property Rule
The three property rule is usually simpler.
Under the three property rule, an investor may generally identify up to three replacement properties without regard to their fair market value.
The 95 percent rule is different because it can involve any number of properties, but the investor must acquire nearly all of the total value identified.
How It Compares to the 200% Rule
The 200% rule may allow an investor to identify more than three properties, as long as the total fair market value of all identified properties does not exceed 200% of the relinquished property value.
This rule may allow the investor to identify more property than the 200% rule permits.
But the investor then generally must acquire replacement property worth at least 95% of the total value of everything identified.
When Might an Investor Use This Rule?
The 95 percent rule may come up when an investor wants to identify many properties and the total value exceeds the 200% rule limit.
This may happen when:
- The investor is buying several smaller properties
- The investor expects nearly all identified properties to close
- The total identified value exceeds the 200% rule limit
- The investor needs a broad identification list
- The investor has already negotiated multiple replacement property purchases
Common Mistakes Investors Make
- Identifying too many properties without understanding the closing requirement
- Assuming the rule means only 95% of one property must close
- Confusing this rule with the 200% rule
- Failing to calculate the total fair market value of all identified properties
- Relying on properties that are not likely to close
- Waiting until the end of the 45 day period to review the identification list
What Happens If You Do Not Meet the Requirement?
If an investor relies on the 95 percent rule but does not acquire enough of the identified property value, the exchange may be disqualified.
That can create a major tax problem because the investor may lose the expected tax deferral.
This is why investors should speak with a Qualified Intermediary and tax professional before relying on this identification method.
Why Most Investors Avoid This Rule
Most investors prefer the three property rule or the 200% rule because they are easier to manage.
This approach can be useful in limited situations, but it leaves very little room for failed closings, financing problems, seller issues, title problems, or last minute deal changes.
If one or more identified properties falls through, the investor may not be able to satisfy the 95% requirement.
How Investors Reduce Risk
Calculate Before Identifying
Add up the fair market value of every property on the identification list before submitting it.
Be Realistic About Closings
Do not rely on this rule unless the identified properties are highly likely to close.
Use Professional Guidance
Review the identification list with a Qualified Intermediary and tax professional before the 45 day deadline.
Bottom Line
The 95 percent rule can allow an investor to identify any number of replacement properties, but it is one of the riskiest identification rules.
The investor generally must acquire replacement property worth at least 95% of the total fair market value of all identified properties.
For most investors, the three property rule or the 200% rule is easier to manage. This rule should be used carefully and only with professional guidance.