In short
The three-property and 200 percent rules leave room for a backup. Why a DST interest belongs on every day-45 list, with the math and the mechanics of naming one.
After day 45 you can only buy what you identified. If the building you wanted falls through on day 90, the exchange fails unless another name on your list can close before day 180. A DST interest is the one replacement that is already owned, already financed and sold by subscription, so it can be the name that saves the exchange. The identification rules leave room for it, and the math below shows how to size it. The full strategy is in our DST backup guide.
The three rules in one paragraph
Reg. section 1.1031(k)-1(c)(4) lets you identify either “three properties without regard to the fair market values of the properties,” or any number of properties whose combined fair market value at the end of the identification period “does not exceed 200 percent of the aggregate fair market value of all the relinquished properties.” If you exceed both limits, paragraph (c)(4)(iii) treats you as if you had identified nothing, unless you end up receiving at least 95 percent of the value you identified. Any property you actually receive before day 45 counts as identified regardless, and you may revoke a name in a signed writing before the period ends under paragraph (c)(6). Our page on how many properties you can identify has the examples.
Why a DST is the natural third name
The two reasons are legal and practical. Legally, a beneficial interest in a properly restricted DST is treated as an interest in real property that can be received in a section 1031 exchange (Rev. Rul. 2004-86). Practically, in the ruling’s facts the trust already owns the property and already has its loan in place; the trustee cannot renegotiate that debt or take new contributions beyond the offering. You are not waiting on a lender, an appraisal or a seller’s cooperation. You are subscribing for an interest in something that exists. That is why a DST can close in days when a building takes months; see how quickly a DST can close.
A deeded backup property, by contrast, carries the same risks as the primary: financing, inspection, title, a seller who walks. Two buildings on a list are two chances at the same kind of failure.
The 200 percent math
A hypothetical. You sold for $1,000,000. Under the 200 percent rule you can identify properties totaling $2,000,000. Suppose you name building A at $1,200,000, building B at $500,000 and a DST interest at $300,000. The total is $2,000,000, inside the limit. If A falls through, B and the DST together absorb only $800,000 of a $1,000,000 exchange, and the $200,000 that is not reinvested is taxable boot. The DST was a partial backup, not a full one.
Now use the three-property rule instead. Name A at $1,200,000, B at $950,000 and a DST interest of up to $1,000,000. Values do not matter under this rule, so the DST can be sized to replace the whole exchange. If A fails, you can put the full $1,000,000 into the DST (subject to the offering’s available capacity, which you confirm before day 45) and defer the entire gain. If A closes, you simply never subscribe. Run your own numbers with your CPA; the point is that the three-property rule lets the backup be as large as the exchange, while the 200 percent rule makes it compete for room.
Where the rules bite
Under the 200 percent rule, the DST’s identified value counts against the cap just like a building’s, so a full-size backup leaves less room for the properties you actually want. Under the three-property rule you have exactly three names, so the DST takes one of them. If you want two buildings and two DSTs, you are back under the 200 percent rule and the sizing problem returns; our page on identifying multiple DSTs under the 200 percent rule works through those cases.
Debt matters too. If you paid off a mortgage at the sale, the replacement side must carry equal debt or you must add cash; a DST’s existing loan is allocated to your interest and counts toward that test. See whether a DST loan counts as replacement debt.
How to write it, and when you can change it
The identification is a signed writing delivered before midnight on day 45 to the intermediary or another party to the exchange who is not a disqualified person (paragraph (c)(2)). Paragraph (c)(3) requires an unambiguous description. For a DST that means the trust’s name, the property it holds by address or name, and the interest you are identifying, stated as a percentage or a dollar amount. Our page on how to identify a DST interest on the day-45 list gives a template.
You can swap names until day 45 by revoking in writing and identifying again. After day 45 the list is frozen; what happens when an identified property falls through after day 45 explains the limited options. Confirming the DST’s capacity and your accredited status before day 45 is what makes the backup real rather than decorative.
What to do now
- Decide on day 1 which rule you are using. If you want a full-size backup, plan for the three-property rule and keep the primary list to two.
- By day 30, have the DST’s offering documents, its remaining capacity and your subscription paperwork in hand, so the name you write on day 45 can actually close.
- Put the DST on the list with the trust name, property and interest size, and keep the delivery receipt.
- If the primary closes, let the backup lapse. If it fails, subscribe before day 180. Start your exchange plan with the backup already chosen.
