Identification

Chapter 24 established that satisfying the identification and exchange periods does not by itself produce an exchange. This chapter establishes the converse: an otherwise flawless exchange fails if the identification is late, misdirected, ambiguous, oversized, or improperly amended. Each of those defects is examined below, and each has voided real transactions.

25.1 The forty-five-day period and the mechanics of identifying

The identification period begins on the date the taxpayer transfers the relinquished property and ends at midnight on the forty-fifth day thereafter.¹ Replacement property that is not identified before the end of that period is treated as property which is not of a like kind to the relinquished property.²

Read the consequence carefully. The regulation does not say that a late identification is disregarded or that the exchange is merely defective. It deems the replacement property not to be like kind, which means the transaction fails the like-kind requirement itself and the taxpayer has a sale.

Two computation rules complete the period. Where more than one relinquished property is transferred on different dates as part of the same deferred exchange, the period is determined by reference to the earliest transfer date.³ Property is transferred when it is disposed of within the meaning of section 1001(a).⁴

The manner of identification. Replacement property is identified only if it is designated as replacement property in a written document signed by the taxpayer and hand delivered, mailed, telecopied, or otherwise sent before the end of the identification period.⁵ Four elements are required, and all four are formal: a writing, the taxpayer's signature, designation of the property as replacement property, and dispatch within the period.

The recipient. The document must be sent to either the person obligated to transfer the replacement property to the taxpayer, regardless of whether that person is a disqualified person, or any other person involved in the exchange other than the taxpayer or a disqualified person.⁶ The regulation names parties to the exchange, an intermediary, an escrow agent, and a title company as examples of persons involved in the exchange.⁷

Two consequences follow, and both are regularly missed.

The seller of the replacement property is always a permissible recipient even if related to the taxpayer, because that person is the one obligated to transfer. The regulation makes the point with a corporation twenty percent owned by the taxpayer, and states expressly that the corporation's status as a disqualified person does not change the result.⁸

The taxpayer's own attorney, accountant, or real estate agent is ordinarily not a permissible recipient, because the agency lookback examined in Chapter 28 makes those persons disqualified. An identification sent only to one's own lawyer is, in the usual case, no identification at all. The intermediary is the correct recipient, and this is one of the reasons the intermediary must not itself be disqualified.

An identification made in a written agreement for the exchange of properties signed by all parties before the end of the identification period satisfies the requirement without a separate notice.⁹

The regulation keys the deadline to sending rather than to receipt, so a document mailed on the forty-fifth day is timely on its face. Proof of dispatch is therefore the record that matters, and identifications should be sent by a method that generates one. The prudent course is to obtain acknowledged receipt as well, because the taxpayer bears the burden of establishing that the identification was made.

25.2 The three-property rule

The taxpayer may identify more than one replacement property. Regardless of the number of relinquished properties transferred as part of the same deferred exchange, the maximum number of replacement properties that may be identified is three, without regard to the fair market values of the properties.¹⁰

The opening clause deserves emphasis. The allowance is three per exchange, not three per relinquished property. A taxpayer disposing of six parcels in a single exchange still identifies three replacement properties, and a taxpayer who wants more must use the rule in 25.3.

If, as of the end of the identification period, the taxpayer has identified more properties than the rules permit, the taxpayer is treated as if no replacement property had been identified.¹¹ The sanction is not that the excess is disregarded. The entire identification is void, subject only to the two exceptions taken up in 25.4 and 25.7.

The rule carries no value ceiling, and the regulation's example makes that concrete. A taxpayer who transferred property worth $100,000 identified three properties worth $75,000, $100,000, and $125,000. Because no more than three properties were identified, the requirements of the three-property rule were satisfied and all three were identified.¹² The aggregate was three times the value of what the taxpayer gave up, and it did not matter.

One counting question recurs in practice and has no clean answer. What constitutes one property is not always obvious, and two adjoining parcels under separate legal descriptions acquired from one seller at one closing may be a single economic acquisition and two identified properties. Where the count is close to the limit, the conservative course is to treat each separately described parcel as a property and to fall back to the two hundred percent rule.

25.3 The two-hundred percent rule

The alternative permits any number of properties to be identified as long as their aggregate fair market value as of the end of the identification period does not exceed 200 percent of the aggregate fair market value of all the relinquished properties as of the date the relinquished properties were transferred.¹³

Two measurement dates appear in that sentence and they are different. The identified properties are valued at the end of the identification period. The relinquished properties are valued on the dates they were transferred. A practitioner who values both sides as of one date has applied a test the regulation does not state, and in a moving market the difference is not academic.

The regulation's example is arithmetically plain. Against a relinquished property worth $100,000, the taxpayer identified four properties worth $30,000, $40,000, $50,000, and $60,000. The aggregate of $180,000 did not exceed 200 percent of $100,000, so all four were identified.¹⁴

The rule is a value ceiling and not a count ceiling. Ten properties are permissible if the aggregate stays within the cap, and this is the mechanism that makes portfolio acquisitions and diversified replacement strategies possible.

The exposure is that fair market value is a question of fact, and the taxpayer establishes it after the transaction rather than before. A taxpayer who identifies $199,000 of property against a $200,000 ceiling has no margin, and a modest upward revaluation of any single identified property voids the identification in its entirety. Where the two hundred percent rule is used, headroom is inexpensive protection, and a contemporaneous valuation file is worth assembling at the time of identification rather than when it is demanded.

Section 25.6 supplies the cautionary example, in which an aggregate of $310,000 against a $100,000 relinquished property cost the taxpayer the exchange.

25.4 The ninety-five percent fallback

Where the taxpayer has identified more properties than the three-property and two hundred percent rules permit, and is therefore treated as having identified nothing, the regulation supplies a second exception. An identification satisfying the rules is nonetheless considered made with respect to any replacement property identified before the end of the identification period and received before the end of the exchange period, but only if the taxpayer receives before the end of the exchange period identified replacement property the fair market value of which is at least 95 percent of the aggregate fair market value of all identified replacement properties.¹⁵

For this purpose, the fair market value of each identified replacement property is determined as of the earlier of the date the property is received by the taxpayer or the last day of the exchange period.¹⁶

The denominator is what makes this rule close to useless, and it is the feature most often misdescribed. The ninety-five percent is measured against all identified replacement properties, including the ones the taxpayer never acquires. A taxpayer who identifies six million dollars of property and closes on five and a half million has received 91.7 percent of the identified value and has satisfied nothing. The identification fails entirely and the taxpayer has a fully taxable disposition.

The rule therefore does not operate as relief for over-identification. It operates as permission to identify a large basket where the taxpayer intends to acquire substantially all of it, which is the realistic use in portfolio transactions. An identification made in reliance on the ninety-five percent rule as a safety net is a plan that collapses at the precise moment it is needed, because the event it must survive is the failure of one identified acquisition.

The valuation timing compounds the difficulty. Because each identified property is valued at the earlier of receipt or the last day of the exchange period, a property the taxpayer declines to acquire is valued at the end of the period at whatever it is then worth. Appreciation in an unacquired property raises the denominator and can defeat the test without any act of the taxpayer.

The counsel is accordingly narrow. Identify within the three-property rule where the transaction permits it, use the two hundred percent rule with genuine headroom where three is not enough, and treat the ninety-five percent rule as a description of a transaction that succeeded rather than as a strategy for one that might not.

25.5 Formal sufficiency: unambiguous description

Replacement property is identified only if it is unambiguously described in the written document or agreement. Real property generally is unambiguously described if it is described by a legal description, street address, or distinguishable name, and the regulation offers the Mayfair Apartment Building as its illustration of the last.¹⁷

The regulation also illustrates failure, and the example describes exactly what an undecided taxpayer is most tempted to write. On June 3, 1991, with the identification period running to July 1, the taxpayer designated the replacement property as "unimproved land located in Hood County with a fair market value not to exceed $100,000," in a signed document personally delivered to the other party. On July 8 the parties agreed that a particular parcel was the property the June 3 document had described. Because the property was not unambiguously described before the end of the identification period, no replacement property was identified.¹⁸

Two lessons follow, and the second is the harder one.

The description must be sufficient on the face of the document and it must be sufficient by the end of the period. A later meeting of the minds does not reach back, and the parties in the example were in complete agreement about what had been meant. Agreement about intent is not the test. The question is whether the writing described the property while the taxpayer still had the right to describe it, and the safe assumption is that a document requiring parol explanation has failed.

A description by category, by county, or by price ceiling is not a description at all. It is a statement of criteria, and criteria are what a taxpayer supplies when the decision has not been made.

Several recurring forms deserve specific attention.

Where the taxpayer will acquire a fractional interest, the identification should state the percentage undivided interest to be acquired. Identifying the entire property and then acquiring part of it raises the separate and more dangerous question examined at 26.1.

Where the taxpayer will acquire an interest in a Delaware statutory trust, the identification should name the trust and state the interest to be acquired, because the property received is the beneficial interest rather than the underlying real estate.

Where a condominium unit or a specific parcel within a larger tract is intended, the unit or parcel designation belongs in the identification. A street address naming a building that contains many units is ambiguous as to which unit.

Where the taxpayer genuinely has not decided, the answer is to identify additional properties within the applicable rule, not to describe one property loosely. Ambiguity is not a way of preserving flexibility. It is a way of identifying nothing.

25.6 Revocation

An identification of replacement property may be revoked at any time before the end of the identification period.¹⁹ It cannot be revoked afterward, which is the first proposition to fix: at midnight on the forty-fifth day the taxpayer's list becomes final for the remainder of the exchange.

Revocation demands the same formality as identification. It is effective only if made in a written document signed by the taxpayer and hand delivered, mailed, telecopied, or otherwise sent before the end of the identification period to the person to whom the identification was sent. An identification made in a written exchange agreement is revoked only by a written amendment to the agreement, or by a written document signed by the taxpayer and sent before the end of the period to all of the parties to the agreement.²⁰

The regulation's paired examples show exactly what turns on the formality.

In the first, the taxpayer identified three properties on June 21, identified two more on June 24, and on June 28 revoked two of the original three by a signed written document personally delivered. Because properly revoked identifications are not taken into account, the taxpayer had identified three properties and satisfied the three-property rule.²¹

In the second, the taxpayer identified two properties on May 20, identified two more on June 4, and on June 5 telephoned the other party and orally revoked the first two. The oral revocation was invalid. All four identifications were taken into account, their aggregate value of $310,000 exceeded 200 percent of the $100,000 relinquished property, and the taxpayer was treated as if no replacement property had been identified. The taxpayer went on to acquire two of the identified properties at the end of July, and lost the exchange on a telephone call made in June.²²

The structural rule these examples encode deserves separate statement, because it is the most dangerous feature of the identification regime and the one that produces failures among careful people. For purposes of the three-property rule, the two hundred percent rule, and the ninety-five percent rule, all identifications of replacement property are taken into account other than those revoked in the prescribed manner.²³

A superseding list does not supersede. A taxpayer who sends a revised identification on day forty without revoking the earlier one has identified the union of both lists, and both the count and the aggregate value are computed on the union. Two successive three-property lists are a six-property identification, and a six-property identification is void unless the aggregate happens to fit within the two hundred percent ceiling.

The drafting consequence should be standing practice. Any amended identification must expressly revoke the prior identification, identifying it by date, must be signed by the taxpayer, and must be sent to every person who received the earlier one. A form that identifies without revoking is a form that accumulates.

25.7 Property acquired within the identification period

Any replacement property received by the taxpayer before the end of the identification period will in all events be treated as identified before the end of the identification period.²⁴ The same property is separately protected against the consequence of over-identification: the rule treating an over-identifying taxpayer as having identified nothing does not apply to replacement property received before the end of the identification period.²⁵

This is a genuine safe harbor for the fast closing, and it removes a pure formality trap. A taxpayer who closes on replacement property on day twenty has identified it whether or not any notice was ever sent.

It does not exempt that property from the counting rules, and the regulation's example is precise about the interaction. A taxpayer transfers property worth $100,000 and receives like-kind property worth $50,000 before the end of the identification period. That property is treated as identified. The taxpayer may then identify either two additional replacement properties of any fair market value, under the three-property rule, or any number of additional replacement properties whose aggregate fair market value does not exceed $150,000, under the two hundred percent rule.²⁶

The second figure states the mechanism. The two hundred percent ceiling is $200,000, the property already received consumes $50,000 of it, and $150,000 of capacity remains. Property received early counts against both rules exactly as identified property does. What it cannot do is fail for want of a notice.

25.8 Identifying property to be produced

A transfer of relinquished property does not fail to qualify for nonrecognition merely because the replacement property is not in existence or is being produced at the time it is identified.²⁷ The terms "produced" and "production" carry the meanings given by section 263A(g)(1) and the regulations under it.²⁸

Property to be produced must be identified under the ordinary rules of 25.1 through 25.6. The regulation states how the description requirement applies to it: where the identified replacement property consists of improved real property and the improvements are to be constructed, the description satisfies the requirement if a legal description is provided for the underlying land and as much detail is provided regarding construction of the improvements as is practicable at the time the identification is made.²⁹

Three points follow.

The land must be described with ordinary precision. The practicability standard reaches the improvements only, not the parcel, and a build-to-suit identification that describes the project but not the land is deficient.

The standard is practicability at the time of identification, which makes the contemporaneous file the evidence. Plans, specifications, a scope of work, and a budget attached to the identification establish what was practicable then. Their absence is difficult to reconstruct once the building exists.

Valuation of property to be produced is its estimated fair market value as of the date it is expected to be received by the taxpayer, and this rule applies for purposes of the two hundred percent rule and the incidental property rule.³⁰ The consequence is decisive and frequently mishandled. The taxpayer values the completed project rather than the raw land. Bare ground worth $400,000 that is expected to be delivered as a finished building worth $2,000,000 is a $2,000,000 identification, and a taxpayer who counted the dirt has almost certainly breached the ceiling.

The receipt side of production exchanges, including the requirement that what is received be substantially the same as what was identified and the treatment of construction unfinished at the end of the exchange period, is taken up at 26.1 and developed as a structure in Chapter 31.