What Is a 1031 Exchange?

Section 1031 of the Internal Revenue Code allows you to defer capital gains tax when you sell a property held for investment or business use, as long as you reinvest the proceeds into a “like-kind” replacement property. You don’t eliminate the tax — you defer it. The gain rolls into the new property’s basis, and you’ll owe tax whenever you eventually sell without doing another exchange.

Some investors chain 1031 exchanges for decades, property after property, deferring the entire gain until death. At that point, their heirs receive a stepped-up basis and the deferred gain disappears entirely. That’s not a loophole — it’s by design, and it’s one of the most powerful wealth-building tools in real estate.

What Qualifies as “Like-Kind”?

The term “like-kind” is broader than most people assume. After the TCJA (Tax Cuts and Jobs Act, effective 2018), 1031 exchanges apply only to real property — not equipment, vehicles, artwork, or other personal property. But within real estate, the definition is extremely flexible:

• An apartment building for a retail strip mall? Like-kind.
• Raw land for a single-family rental? Like-kind.
• A warehouse for an office building? Like-kind.
• U.S. property for foreign property? Not like-kind. Both properties must be within the U.S.

The property must be held for productive use in a trade or business or for investment. Your primary residence doesn’t qualify. A vacation home you personally use most of the year probably doesn’t qualify either, though there are narrow exceptions if you also rent it out and meet specific use tests under IRS Publication 527.

The 45-Day Identification Window

This is the deadline that makes or breaks most exchanges. From the day you close on the sale of your relinquished property, you have exactly 45 calendar days to identify potential replacement properties in writing. Not business days. Calendar days. Day 45 falls on a Sunday? Tough. Saturday of a holiday weekend? Still the deadline.

You must provide written identification to your qualified intermediary or the seller of the replacement property. The identification must describe the property with reasonable specificity — street address for real estate is standard.

The Three Rules for Identification

You can identify replacement properties under one of three rules per Treasury Regulation § 1.1031(k)-1:

• Three-Property Rule: Identify up to three properties of any value. This is the most commonly used rule. You don’t have to acquire all three — just close on at least one within the 180-day window.
• 200% Rule: Identify any number of properties, but their combined fair market value can’t exceed 200% of the relinquished property’s sale price. Sell for $500,000? Your identified properties can’t total more than $1,000,000.
• 95% Rule: Identify any number of properties at any value, but you must acquire at least 95% of the total value identified. This rule is rarely used because it’s so unforgiving.

Most investors stick with the three-property rule. It’s simple and gives you options if one deal falls through.

The 180-Day Completion Deadline

You have 180 calendar days from the sale of your relinquished property to close on the replacement property. This runs concurrently with the 45-day identification period, not after it. So you really have 135 days after identification to close.

There’s a catch that surprises some people: the 180-day deadline can be shortened if your tax return is due before the 180 days expire. If you sell a property on November 15 and your tax return is due April 15 (151 days later), your exchange deadline is April 15 unless you file an extension. Always file an extension in exchange years. It costs nothing and protects your timeline.

Qualified Intermediary Requirement

You can’t touch the money. Period. The sale proceeds must be held by a qualified intermediary (QI) — a third party who holds the funds between the sale and the purchase. If the money hits your bank account, even briefly, the exchange is disqualified under IRC § 1031(a)(3).

Your QI cannot be your real estate agent, attorney, accountant, or anyone who has served in those roles for you within the past two years. The QI must be genuinely independent. They hold the funds in escrow, and when you close on the replacement property, they direct the payment.

One risk to know about: QI funds are generally not FDIC insured. If your QI goes bankrupt while holding your money, you could lose it. Vet your QI carefully. Ask about their insurance, bonding, and how they segregate client funds. Our tax advisory team can recommend vetted intermediaries.

Boot: When Part of Your Exchange Gets Taxed

“Boot” is the IRS term for any value you receive in an exchange that doesn’t qualify for tax deferral. If you don’t reinvest all the proceeds, the difference is boot and gets taxed as a capital gain.

Boot comes in two forms:

• Cash boot: You sell for $600,000 and only buy a replacement for $500,000. The $100,000 difference is taxable boot.
• Mortgage boot: Your old property had a $300,000 mortgage. Your new property only has a $200,000 mortgage. The $100,000 reduction in debt is boot. The IRS treats debt relief the same as receiving cash.

To fully defer your gain, two things need to happen: (1) the replacement property must be equal or greater in value than the relinquished property, and (2) all equity from the sale must go into the new property. Anything short of that creates taxable boot.

Reverse Exchanges

Sometimes you find the perfect replacement property before you’ve sold your existing one. A reverse exchange handles this — you acquire the new property first, then sell the old one. The mechanics are more complicated: an exchange accommodation titleholder (EAT) takes title to one of the properties during the exchange period, as outlined in Revenue Procedure 2000-37.

Reverse exchanges are more expensive (expect higher QI and EAT fees) and have the same 45/180-day deadlines running from the acquisition of the replacement property. But they solve a real problem in competitive markets where you can’t afford to wait for a buyer before locking down the next deal.

Related Party Rules

Exchanges with related parties (family members, controlled entities) are allowed but come with extra restrictions under IRC § 1031(f). If you acquire a replacement property from a related party, both you and the related party must hold your respective properties for at least two years after the exchange. If either party sells within two years, the deferred gain gets triggered.

The IRS defines related parties broadly: siblings, spouses, ancestors, lineal descendants, and entities where you own more than 50%. Don’t try to get creative with related-party exchanges without professional guidance — the audit risk is real.

Delaware Statutory Trusts (DSTs)

DSTs have become a popular replacement property option for investors who want passive real estate exposure without being a landlord. A DST is a legal entity that holds title to real property, and investors buy beneficial interests. The IRS has approved DSTs as qualifying replacement property for 1031 exchanges (Revenue Ruling 2004-86).

DSTs are particularly appealing for older investors doing their “last” exchange. Instead of buying another building to manage, they exchange into a professionally managed DST and collect distributions. The minimum investment is typically $100,000-$250,000, and many institutional-grade properties are available through DST sponsors.

The downside: DSTs are illiquid, charge significant fees, and you give up control over property management and sale timing. They’re a tool for specific situations, not a default replacement strategy. For investors also considering the tax implications of selling versus exchanging, understanding your current tax bracket can help frame the decision. And if you’re a self-employed real estate investor, the SE tax implications of your activities are worth reviewing alongside any exchange planning. Consider consulting our business tax team for a full analysis, and explore whether a backdoor Roth IRA could complement your real estate deferral strategy.

Sources & References

• 26 U.S.C. § 1031 — Exchange of Real Property Held for Productive Use or Investment
• 26 U.S.C. § 1014 — Basis of Property Acquired from a Decedent (stepped-up basis)
• 26 CFR § 1.1031(k)-1 — Treatment of Deferred Exchanges (45/180-day rules)
• IRS Publication 544 — Sales and Other Dispositions of Assets
• IRS Publication 527 — Residential Rental Property
• IRS Revenue Ruling 2004-86 — DSTs as Qualifying Replacement Property
• IRS Revenue Procedure 2000-37 — Reverse Exchange Safe Harbor
• IRS Topic No. 409 — Capital Gains and Losses