TL;DR
A 1031 exchange allows real estate investors to defer capital gains taxes by reinvesting the proceeds from a property sale into a like-kind replacement property. The process requires strict adherence to IRS timelines: you must identify replacement properties within 45 days and close within 180 days. A qualified intermediary must hold the funds throughout the transaction. When executed properly, a 1031 exchange can preserve hundreds of thousands of dollars in tax liability, enabling you to build wealth faster and compound your real estate portfolio over time.
What Is a 1031 Exchange in Real Estate?
Section 1031 of the Internal Revenue Code is one of the most powerful tax-deferral strategies available to real estate investors. A 1031 exchange, also called a like-kind exchange, allows you to sell an investment or business-use property and reinvest the proceeds into a similar property while deferring all capital gains taxes on the sale.
The key word is deferral, not elimination. Taxes are postponed until you eventually sell the replacement property in a taxable transaction. However, many investors execute sequential 1031 exchanges over their entire investing career, and under current law, heirs who inherit exchanged property receive a stepped-up basis that can eliminate the deferred gains entirely.
According to the IRS, owners of investment and business property may qualify for a Section 1031 deferral, including individuals, C corporations, S corporations, partnerships, limited liability companies, and trusts. Personal residences and property held primarily for sale (such as fix-and-flip inventory) do not qualify.
What Qualifies as Like-Kind Property?
Under the 1031 exchange rules, "like-kind" is broadly defined for real estate. Any real property held for investment or business use can be exchanged for any other real property held for the same purpose. Quality and grade do not matter. You can exchange a single-family rental home for an apartment complex, vacant land for a commercial office building, or a retail strip center for an industrial warehouse.
Since the Tax Cuts and Jobs Act of 2017, Section 1031 applies exclusively to real property. Personal property such as vehicles, equipment, artwork, and collectibles no longer qualifies. Property located within the United States must be exchanged for other U.S. property, and foreign real estate must be exchanged for foreign real estate.
Properties That DO NOT Qualify for a 1031 Exchange
Your primary residence or vacation home used exclusively for personal purposes, property held primarily for resale (dealer property or fix-and-flip inventory), stocks, bonds, partnership interests, notes, or other securities, and any personal property including equipment, vehicles, or furniture as standalone assets.
Working With an Agent Who Understands 1031 Exchanges?
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Find a Top-Performing Agent1031 Exchange Requirements: The Rules You Must Follow
The IRS imposes strict 1031 exchange requirements that must be met precisely. Failing any single requirement can disqualify the entire exchange and trigger immediate tax liability on all capital gains. Here are the core requirements every investor must satisfy.
Property Must Be Held for Investment or Business Use
Both the relinquished property (the one you sell) and the replacement property (the one you buy) must be held for productive use in a trade or business or for investment. The IRS does not specify a minimum holding period, but most tax advisors recommend holding property for at least 12 to 24 months to establish investment intent. A property you purchase and immediately resell will not meet the investment-use standard.
Same Taxpayer Requirement
The same taxpayer who sells the relinquished property must acquire the replacement property. If an LLC sells the property, the same LLC must be on the title of the replacement property. Partnerships and co-ownership structures add complexity, and investors should consult a tax advisor before attempting an exchange involving entity changes.
Equal or Greater Value
To defer 100% of capital gains, the replacement property must have a fair market value equal to or greater than the relinquished property. Additionally, all net equity from the sale must be reinvested, and the debt on the replacement property must be equal to or greater than the debt paid off on the relinquished property. Falling short on any of these metrics creates taxable "boot," which we cover in detail below.
Qualified Intermediary Requirement
Federal law prohibits investors from touching the sale proceeds at any point during the exchange. A qualified intermediary (QI), also called an exchange accommodator, must hold the funds in escrow from the date you close on the relinquished property until the day you close on the replacement property. The QI cannot be your agent, attorney, accountant, broker, or any other person who has acted as your agent within the previous two years.
The 1031 Exchange Timeline: 45-Day and 180-Day Rules
The 1031 exchange timeline is the single most critical factor in a successful exchange. There are two firm deadlines that begin running the day after you close on the sale of your relinquished property, and they run concurrently (not sequentially).
The 45-Day Identification Period
Within 45 calendar days of closing on the sale of your relinquished property, you must submit a written identification of potential replacement properties to your qualified intermediary. This identification must include a clear description of each property (legal description, street address, or distinguishable name) and be signed by you. These 45 days are absolute. They cannot be extended even if the 45th day falls on a weekend or federal holiday (except in rare cases involving presidentially declared disaster areas under Revenue Procedure 2018-58).
Identification Rules: Three Methods
Three-Property Rule
You may identify up to three potential replacement properties regardless of their individual or aggregate fair market value. This is the most commonly used identification method for how to do a 1031 exchange.
200% Rule
You may identify more than three properties, but the total fair market value of all identified properties cannot exceed 200% of the value of the relinquished property you sold.
95% Exception Rule
If you identify properties exceeding the 200% threshold, you can still qualify if you actually acquire at least 95% of the aggregate fair market value of all identified properties. This rule is extremely difficult to satisfy and is rarely used in practice.
The 180-Day Exchange Period
You must close on your replacement property within the earlier of: 180 calendar days after closing on your relinquished property, or the due date (including extensions) of your income tax return for the year in which the relinquished property was sold. This second condition catches many investors off guard. If you sell a property late in the calendar year, the 180-day window may extend past your tax filing deadline. In that case, you must file a tax extension to preserve the full 180 days.
Tax Filing Deadline Trap: Example
Solution: File Form 4868 for a six-month tax extension to preserve the full 180-day window. The extension delays only the filing deadline, not the payment of any taxes already owed on other income.
How to Do a 1031 Exchange: Step-by-Step Process
Executing a 1031 exchange requires careful coordination among multiple parties. Here is the step-by-step process most investors follow in a standard delayed (forward) exchange, which accounts for the vast majority of all 1031 transactions.
Understanding Boot in a 1031 Exchange
In 1031 exchange terminology, "boot" refers to anything received in the exchange that is not like-kind real property. Boot does not disqualify your exchange, but the amount of boot you receive is taxable up to the amount of your realized gain. Understanding boot is essential because it can arise from several common situations that investors may not anticipate.
Types of Boot in a Like-Kind Exchange
Cash Boot
Occurs when you do not reinvest all sale proceeds. If you sell for $500,000 but only reinvest $400,000, the remaining $100,000 is cash boot and is taxable.
Mortgage (Debt) Boot
Occurs when the mortgage on the replacement property is less than the mortgage paid off on the relinquished property. The difference in debt relief is taxable boot.
Personal Property Boot
Any non-real-estate items received in the transaction (furniture, equipment, appliances included in the purchase price) are classified as personal property boot.
Non-Exchange Expense Boot
Certain closing costs paid from exchange funds (such as tenant security deposits, rent prorations, or non-qualified expenses) can inadvertently create boot.
Boot Calculation Example
Scenario: Trading Down Creates Taxable Boot
In this scenario, the investor would owe capital gains tax on $150,000 of boot. At a combined federal long-term capital gains rate of 20% plus 3.8% Net Investment Income Tax, that translates to approximately $35,700 in tax liability, plus potential depreciation recapture at 25%.
How to Avoid Boot Entirely
Follow the "trade across or up" rule. Purchase replacement property with a value equal to or greater than the relinquished property. Reinvest all net sale proceeds. Take on equal or greater debt on the replacement property. Pay non-qualified closing costs with outside funds rather than exchange proceeds. If you have leftover equity you cannot deploy, consider investing the remainder in a Delaware Statutory Trust to achieve full deferral.
Find an Agent Experienced in 1031 Exchange Transactions
The timing of a 1031 exchange leaves zero margin for error. A top-performing agent understands the deadlines, pricing implications, and transaction coordination that make or break your tax deferral.
Get Matched With a Vetted Agent1031 Exchange Tax Savings Framework
Use this framework to estimate how much you could save in deferred taxes by completing a 1031 exchange instead of a standard taxable sale. Enter your property details below to see the potential capital gains tax deferral at different price points.
1031 Exchange Tax Savings Estimator
Your Estimated Tax Deferral
This estimate uses maximum federal rates. Your actual tax liability may vary based on income level, state taxes, and filing status. Consult a qualified tax advisor for personalized guidance.
Example Savings at Different Price Points
| Sale Price | Cost Basis | Depreciation | Est. Capital Gains Tax | Tax Deferred via 1031 |
|---|---|---|---|---|
| $400,000 | $250,000 | $50,000 | ~$45,200 | $45,200 |
| $750,000 | $400,000 | $100,000 | ~$108,500 | $108,500 |
| $1,200,000 | $650,000 | $175,000 | ~$177,250 | $177,250 |
| $2,000,000 | $1,000,000 | $300,000 | ~$313,000 | $313,000 |
Types of 1031 Exchanges: Delayed, Reverse, and DST Options
While the delayed forward exchange is the most common structure, real estate investors have several options for how to do a 1031 exchange depending on their circumstances.
Delayed (Forward) Exchange
This is the standard 1031 exchange structure. You sell the relinquished property first, the QI holds the proceeds, and you acquire the replacement property within the 45/180-day timelines. Approximately 95% of all 1031 exchanges follow this structure.
Simultaneous Exchange
Both the relinquished and replacement properties close on the same day. While conceptually simple, simultaneous exchanges are difficult to coordinate and carry significant risk if either side experiences delays. A QI is still recommended to ensure compliance.
Reverse 1031 Exchange
In a reverse exchange, you acquire the replacement property before selling the relinquished property. This is useful in competitive markets where you find the perfect investment property before your current property has sold. Because you cannot hold title to both properties simultaneously, an Exchange Accommodation Titleholder (EAT) takes title to either the new property or the old property for up to 180 days while you complete the sale. Reverse exchanges are governed by IRS Revenue Procedure 2000-37 and are substantially more expensive than standard exchanges due to the additional legal, holding, and financing costs.
Improvement (Build-to-Suit) Exchange
This variation allows investors to use exchange funds to make improvements on the replacement property before taking title. The EAT holds title while construction occurs, and all improvements must be complete before the 180-day deadline. This approach is useful when the replacement property needs significant renovation to match the value of the relinquished property.
Delaware Statutory Trust (DST) as 1031 Replacement Property
A Delaware Statutory Trust is a legal entity formed under Delaware law that holds title to real property. Following IRS Revenue Ruling 2004-86, beneficial interests in a properly structured DST qualify as like-kind replacement property for 1031 exchange purposes. DSTs have become an increasingly popular option for investors who want to transition from active property management to passive ownership while still deferring capital gains.
Benefits of DST for 1031 Exchanges
Access to institutional-grade properties (class A multifamily, industrial, medical office), minimum investments typically starting at $100,000, faster closing timelines (often 3 to 5 business days), no active management responsibilities, and the ability to invest any leftover exchange proceeds to avoid boot.
DST Limitations to Consider
Only available to accredited investors (net worth over $1 million or income exceeding $200,000), limited liquidity with typical hold periods of 3 to 10 years, no direct control over property operations, and the "seven deadly sins" constraints of Revenue Ruling 2004-86 limit the trustee's operational flexibility.
Many experienced investors use DSTs as a backup property on their identification list. If the primary identified property falls through, a DST can be acquired quickly to preserve the exchange and meet the 180-day deadline. This strategy is particularly valuable given the strict timelines of the closing process.
Common 1031 Exchange Mistakes That Trigger Taxes
Even experienced real estate investors make costly mistakes when executing a 1031 exchange. These are the errors most likely to disqualify your exchange or create unexpected tax liability.
Missing the 45-Day or 180-Day Deadline
The timelines are non-negotiable. There are no extensions for personal circumstances, negotiation delays, or financing complications. The only exception is a presidentially declared disaster affecting your area. Build a timeline buffer by beginning your replacement property search before your relinquished property closes.
Touching the Proceeds
If you receive any portion of the sale proceeds at any point during the exchange, even briefly, the exchange is disqualified. All funds must flow through the qualified intermediary. Make sure your closing agent is fully informed that this is a 1031 exchange transaction.
Using a Disqualified Person as QI
Your attorney, CPA, real estate agent, employee, or anyone who has served as your agent within the previous two years cannot act as your qualified intermediary. The IRS requires a truly independent third party.
Failing to Match Value, Equity, and Debt
Trading down in property value, equity invested, or mortgage debt creates taxable boot. Run a detailed analysis with your QI and tax advisor before committing to a replacement property to confirm you are meeting the equal-or-up requirements.
Changing Entity Ownership Mid-Exchange
The same taxpayer on the relinquished property deed must appear on the replacement property deed. Transferring property into or out of an LLC, partnership, or trust during the exchange can disqualify it entirely. If you need to restructure ownership, consult a 1031 exchange attorney well in advance.
Overlooking the Tax Filing Deadline
If you sell a property in the fourth quarter and your 180-day window extends past April 15, you must file a tax extension or your exchange period is effectively shortened. This is a surprisingly common trap, particularly for investors closing year-end transactions. Always file Form 4868 as a precautionary measure when your exchange spans two tax years.
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Find a Top Agent in Your MarketReporting a 1031 Exchange on Your Tax Return
Every 1031 exchange must be reported to the IRS using Form 8824, "Like-Kind Exchanges," which is filed with your income tax return for the year in which the relinquished property was sold. Even if the exchange is completed in the following tax year, the Form 8824 is filed with the return for the year the sale occurred.
Key Information Needed for Form 8824
You will need a complete exchange agreement from your qualified intermediary, descriptions and dates of both the relinquished and replacement properties, all closing statements (HUD-1 or ALTA settlement statements), the adjusted basis of the relinquished property, depreciation schedules, and a detailed log of the 45-day identification and 180-day exchange timeline dates. Your qualified intermediary will typically provide a summary document at the conclusion of the exchange that contains most of this information.
Tracking Your Basis Going Forward
The basis of your replacement property carries over from the relinquished property (with adjustments for any boot paid or received). This is important because the deferred gain remains embedded in the replacement property. If you sell the replacement property in a taxable transaction in the future, you will owe taxes on both the original deferred gain and any new appreciation. Keeping meticulous records across multiple exchanges is critical, especially if you plan to execute sequential 1031 exchanges over time.
Stepped-Up Basis at Death
Under current law, heirs who inherit real estate receive a stepped-up basis equal to the property's fair market value at the date of death. This means all deferred gains from prior 1031 exchanges may be eliminated entirely. This makes serial 1031 exchanging a powerful long-term wealth-building and estate planning strategy.
State-Level Considerations
Some states have additional reporting requirements for 1031 exchanges. California, for example, requires investors to file Form 3840 to track deferred gains within the state. If you are exchanging into property in a different state, you may be subject to tax obligations in both states. Consult a tax professional familiar with multi-state 1031 exchange rules.
Frequently Asked Questions About 1031 Exchanges
Can I do a 1031 exchange on my primary residence?
No. Section 1031 applies only to property held for investment or business use. Your primary residence and vacation homes used exclusively for personal purposes do not qualify. However, if you convert a primary residence to a rental property and hold it for a sufficient period to establish investment intent (most advisors recommend at least 12 to 24 months of rental use), it may then qualify for a 1031 exchange. Note that you cannot combine the Section 121 primary residence exclusion ($250,000/$500,000) with a 1031 exchange on the same transaction without careful planning and IRS compliance.
How long do I have to complete a 1031 exchange?
You have 45 calendar days from the closing of your relinquished property sale to identify potential replacement properties, and 180 calendar days (or the due date of your tax return, whichever comes first) to close on the replacement. These deadlines run concurrently, meaning the 180-day clock starts at the same time as the 45-day clock, not after it ends. The IRS does not grant extensions except in cases of federally declared disasters.
What happens if my 1031 exchange fails?
If you fail to identify replacement properties within 45 days or close within 180 days, the exchange is disqualified. The qualified intermediary returns any remaining funds to you, and the entire sale is treated as a taxable transaction. You will owe capital gains tax and depreciation recapture tax on the full gain from the sale of your relinquished property, plus potential penalties and interest if the resulting taxes are not paid timely.
Can I exchange into multiple replacement properties?
Yes. You can identify up to three replacement properties under the Three-Property Rule regardless of value, or more than three under the 200% Rule (as long as total value does not exceed 200% of the relinquished property). You can close on any one, two, or all three of your identified properties. Many investors use this strategy to diversify from a single high-value property into multiple smaller investments, or to combine a direct property purchase with a DST investment to deploy all exchange proceeds.
How much does a qualified intermediary charge for a 1031 exchange?
Qualified intermediary fees for a standard delayed exchange typically range from $600 to $1,200, depending on the complexity of the transaction and the QI firm. Reverse exchanges are significantly more expensive, often costing $5,000 to $15,000 or more due to the additional accommodation titleholder structure, legal documentation, and holding costs. When selecting a QI, consider their experience, insurance coverage, fee transparency, and membership in the Federation of Exchange Accommodators.
Is a 1031 exchange the same as avoiding taxes?
No. A 1031 exchange is a tax deferral, not tax avoidance or elimination. The capital gains taxes you would have paid are deferred until you sell the replacement property in a taxable transaction. However, by executing sequential 1031 exchanges throughout your investing career, you can continue deferring taxes indefinitely. If you hold the property until death, your heirs may receive a stepped-up basis under current law, which can effectively eliminate all deferred gains.
Can I do a 1031 exchange between states?
Yes. You can sell a property in one state and purchase a replacement property in any other state within the United States. However, be aware that some states have "clawback" provisions or additional reporting requirements when deferred gains leave the state. California's Form 3840 is the most well-known example. Consult a tax professional familiar with multi-state like-kind exchange real estate transactions to ensure compliance.
What is the difference between a 1031 exchange and a Delaware Statutory Trust?
A 1031 exchange is a tax strategy under IRS Section 1031 that allows you to defer capital gains by reinvesting in like-kind property. A Delaware Statutory Trust (DST) is a type of replacement property you can acquire within a 1031 exchange. A DST holds title to real estate and sells fractional beneficial interests to investors. Per IRS Revenue Ruling 2004-86, DST interests qualify as like-kind property. DSTs are popular for investors seeking passive ownership of institutional-grade real estate, and they are particularly useful for deploying leftover exchange proceeds or as backup properties on the 45-day identification list.
