What Is a 1031 Exchange?
A 1031 exchange — named after Section 1031 of the Internal Revenue Code — allows you to sell investment or business property and defer federal (and often state) capital gains tax by reinvesting the proceeds into a “like-kind” replacement property.
Without a 1031 exchange, selling appreciated real estate triggers capital gains tax at rates up to 20% plus the 3.8% Net Investment Income Tax, plus depreciation recapture at 25%. A well-executed exchange defers all of this indefinitely.
What Qualifies
Property that qualifies:
- Investment real estate (rental homes, apartment buildings, commercial properties)
- Business-use real estate (office buildings, warehouses, farm land)
- Vacant land held for investment
Property that does not qualify:
- Primary residences (though a partial exclusion may apply under Section 121)
- Property held primarily for sale (dealer inventory, fix-and-flips)
- Personal property (the 2017 Tax Cuts and Jobs Act eliminated 1031 treatment for non-real-estate assets)
- Foreign property exchanged for U.S. property (and vice versa — must be like-kind within the same country)
The Key Timelines
A 1031 exchange has two hard deadlines that cannot be extended:
45-day identification period: From the date you close on the sale of the relinquished property, you have 45 calendar days to formally identify potential replacement properties in writing to your Qualified Intermediary. You may identify up to three properties (the “3-property rule”), any number of properties with a combined fair market value up to 200% of the relinquished property (the “200% rule”), or any number of properties if you actually close on 95% of their combined value.
180-day exchange period: You must close on the replacement property within 180 calendar days of the relinquished property sale (or by the due date of your tax return, whichever is earlier). The 180-day window runs concurrently with the 45-day window — it does not start over after identification.
Both deadlines are absolute. Missing either by even one day disqualifies the exchange entirely.
The Qualified Intermediary Requirement
You cannot receive the sale proceeds, even temporarily. The IRS requires a Qualified Intermediary (QI) — an independent third party — to hold the exchange funds between the sale and the purchase. If proceeds touch your hands or your agent’s hands at any point, the exchange is disqualified.
Select your QI before closing on the sale. The QI cannot be your attorney, accountant, realtor, or anyone who has acted as your agent in the prior two years.
Boot and Partial Exchanges
Boot is any non-like-kind property received in the exchange — typically cash, net mortgage relief, or personal property. Boot is taxable in the year of the exchange.
To fully defer tax, you must:
- Purchase replacement property of equal or greater value than the relinquished property
- Use all cash proceeds in the purchase (reinvest 100% of equity)
- Replace any mortgage on the relinquished property with equal or greater debt on the replacement
If you receive some cash or net fewer liabilities, you pay tax only on the boot — the rest of the gain is still deferred.
Reverse and Build-to-Suit Exchanges
Reverse exchange: You acquire the replacement property before selling the relinquished property. This requires a more complex structure (an Exchange Accommodation Titleholder holds one of the properties) and strict 45/180-day timelines apply from the date of acquisition.
Build-to-suit (improvement) exchange: Allows you to use exchange funds for construction or improvements on the replacement property. The improvements must be substantially complete within the 180-day window.
Both structures require advance planning and experienced intermediaries.
Depreciation Recapture
Deferred gain includes accumulated depreciation on the relinquished property. When you ultimately sell the replacement property in a taxable sale, depreciation recapture is taxed at 25% — not at capital gains rates. 1031 exchanges defer this recapture; they do not eliminate it.
One popular strategy: exchange properties throughout your lifetime, then pass them to heirs. At death, heirs receive a stepped-up basis equal to fair market value, potentially eliminating the deferred gain entirely.
Last updated: February 2025