1031 Exchange:
Defer Taxes, Grow Your Portfolio
A 1031 exchange lets real estate investors sell a property and reinvest the full proceeds into a new one, deferring capital gains taxes and keeping more money working for them.
What Is a 1031 Exchange?
Named after IRS Section 1031 of the Internal Revenue Code, a 1031 exchange (also called a "like-kind exchange") allows a real estate investor to sell an investment property and defer paying capital gains taxes — as long as they reinvest the proceeds into another like-kind property within a specific timeframe.
Key Distinction
1031 exchanges defer taxes, they do not eliminate them. Taxes are owed when the investor eventually sells without completing another exchange.
Legislative Note
As of July 2025, 1031 exchange provisions for real property were made permanent under the One Big Beautiful Bill Act (OBBBA). Prior proposals to cap exchanges at $500,000 were not enacted.
Why Investors Use a 1031 Exchange
Defer Capital Gains Tax
Avoid paying 0–20% federal capital gains tax at the time of sale.
Compound Growth
Reinvest 100% of proceeds — not the after-tax remainder — into the next property.
Defer Depreciation Recapture
Avoid the 25% depreciation recapture tax on prior deductions.
Diversify Holdings
Exchange one property into multiple replacement properties.
Portfolio Upgrade
Exchange into a larger, higher-value, or more strategically located property.
Do You Qualify?
Property Type — Both the relinquished (sold) property and the replacement (purchased) property must be real property held for investment or business use. Primary residences do not qualify.
Like-Kind Rule — Any U.S. investment real estate qualifies as "like-kind" to any other U.S. investment real estate — e.g., a single-family rental can be exchanged for an apartment complex, commercial building, or vacant land.
Same Taxpayer — The same taxpayer (individual, LLC, or entity) who sells the relinquished property must purchase the replacement property.
Investment Intent — The property must be held for investment or productive use in a trade or business — not purchased with the intent to immediately resell (flip).
Personal Property Excluded — As of the Tax Cuts and Jobs Act (TCJA), only real property qualifies. Equipment, vehicles, and other personal property are excluded.
Ineligible Properties: Primary residences; Fix-and-flip properties (held for resale); Stocks, bonds, or personal property; Foreign real property exchanged for U.S. real property
The 1031 Exchange Timeline
Close on the Sale
Close on the sale of the relinquished property. The exchange period begins, and all proceeds must go directly to the Qualified Intermediary (QI) — not to the investor.
Identification Deadline
The investor must submit a written list to the QI identifying up to three potential replacement properties, following the IRS identification rules.
Exchange Deadline
The investor must close on the purchase of at least one identified replacement property to complete the exchange and defer the capital gains tax.
Identification Rules
- 3-Property Rule (most common): Identify up to 3 properties of any value.
- 200% Rule: Identify any number of properties as long as their combined fair market value does not exceed 200% of the relinquished property's sale price.
- 95% Rule: Identify any number of properties, but must close on 95% or more of their combined value.
Year-End Deadline Warning
If the relinquished property closes after October 17 in any given year, the 180-day window may extend past the April 15 tax deadline. In this case, the investor must file a tax extension (Form 4868) to preserve the full 180-day exchange period.
Example: An investor sells their relinquished property on November 1, 2025. Their 180-day exchange window would normally end on April 30, 2026 — which is past the April 15, 2026 tax deadline. Without filing Form 4868, the IRS would cut the exchange period short to April 15, leaving the investor only ~165 days instead of 180. By filing Form 4868, the tax deadline is extended to October 15, 2026, restoring the full 180-day window (ending April 30, 2026) and giving the investor adequate time to close on a replacement property.
The 45-day and 180-day deadlines cannot be extended except in Federally declared disasters.
Types of 1031 Exchange
Delayed Exchange
Most common
How it works: Sell the relinquished property first, then identify and purchase the replacement property within the 45/180-day windows. The most common type.
Best for: Most investors
Simultaneous Exchange
How it works: The sale of the relinquished property and the purchase of the replacement property close on the same day. Rare and logistically difficult.
Best for: Very specific coordinated transactions
Reverse Exchange
How it works: Purchase the replacement property before selling the relinquished property. A QI holds the replacement property via an Exchange Accommodation Titleholder (EAT). Investor has 45 days to identify the property to sell and 180 days to complete the sale.
Best for: Hot markets where the investor needs to secure a replacement property quickly
Improvement Exchange
How it works: Also called a build-to-suit or construction exchange. The investor uses exchange proceeds to make improvements on the replacement property before taking title. Improvements must be completed and title transferred within the 180-day window.
Best for: Properties requiring renovation or new construction
The Qualified Intermediary: A Required Partner
What a QI Does
- Holds the sale proceeds from the relinquished property in a segregated escrow account.
- Prepares the exchange agreement documentation.
- Receives the investor's written property identification by the 45-day deadline.
- Transfers funds to purchase the replacement property at closing.
How to Select a QI
- Choose before closing on the sale of the relinquished property.
- Look for QIs who are members of the Federation of Exchange Accommodators (FEA).
- Verify that funds are held in a separate, bonded escrow account.
- Ask about their fidelity bond and errors & omissions (E&O) insurance.
Why a QI Is Required
If the investor receives the sale proceeds directly — even briefly — the IRS considers the exchange to have been "actually or constructively received," and the entire tax deferral is lost.
Who Cannot Serve as QI (Disqualified Persons): The investor themselves; the investor's agent, broker, attorney, accountant, or employee within the past 2 years; a family member.
Important: QIs are not regulated by the federal government. Due diligence in selection is critical.
Key Tax Concepts Explained
Capital Gains
Definition: The profit made when a property is sold for more than its cost basis (purchase price + improvements + acquisition costs).
Formula: Capital Gain = Sale Price − Cost Basis
Tax rate: Long-term capital gains (property held > 1 year) are taxed at 0%, 15%, or 20% depending on the investor's income. Short-term gains (held < 1 year) are taxed as ordinary income (up to 37%).
1031 relevance: A 1031 exchange defers this entire tax.
Boot
Definition: Any cash or non-like-kind property received in an exchange that is taxable.
- Receiving cash proceeds from the exchange
- Replacement property has a lower value than the relinquished property
- Replacement property has a lower mortgage balance than the relinquished property (mortgage boot)
Tax treatment: Boot is taxed — depreciation recapture first (25%), then long-term capital gains (0–20%).
How to avoid: Reinvest all proceeds and take on equal or greater debt on the replacement property.
Depreciation Recapture
Definition: When a rental property is sold, the IRS "recaptures" the depreciation deductions the investor claimed over the years and taxes that amount at a flat 25%.
Example: An investor claimed $80,000 in depreciation over 10 years. When the property is sold, $80,000 is taxed at 25% = $20,000 owed.
1031 relevance: A 1031 exchange defers depreciation recapture as well as capital gains tax. The accumulated depreciation carries over to the replacement property and is recaptured when that property is eventually sold without an exchange.
Step-Up in Basis
Definition: When a property owner passes away, the cost basis is "stepped up" to the fair market value at the date of death, eliminating all accumulated capital gains and deferred depreciation recapture for the heirs.
Example: An investor bought a property for $200,000 and deferred taxes through multiple 1031 exchanges. At death, the property is worth $2,000,000. The heir's cost basis is $2,000,000 — selling at that price results in $0 capital gains tax.
Strategy implication: Many long-term investors use repeated 1031 exchanges throughout their lifetime, intending to pass property to heirs at a stepped-up basis — effectively eliminating the deferred tax liability permanently.
Estate tax note: Step-up in basis applies regardless of estate tax liability. For 2026, the federal estate tax exemption is approximately $15,000,000 per individual (per OBBBA).
Tax rates shown are approximate. Consult a qualified tax professional for rates applicable to your specific situation.
Common 1031 Exchange Mistakes to Avoid
FAQs
Learn about 1031 Exchange
Related Learning Resources
View all
1031 Exchange Traps: Three Mistakes That Will Instantly Trigger a Tax Bill
Jun 27, 2026
A 1031 Exchange is arguably the greatest wealth-building tool in the tax code, but it is not forgiving. The IRS views it as a strict legal procedure, and even a minor technical…
The Ultimate 1031 Exchange Timeline & Pre-Listing Checklist
Jun 27, 2026
The secret to a flawless 1031 exchange isn’t what you do after you sell your investment property—it’s what you do before the property ever hits the market. Because the IRS…
Crushing the 1031 Deadline: Why Investors Use Delaware Statutory Trusts (DSTs)
Jun 27, 2026
The 1031 exchange is brilliant for tax deferral, but executing one in a highly competitive real estate market can feel like a high-stakes race against time. Finding a quality…
Ready to Defer Your Taxes?
Talk to our team. We'll help you defer your taxes and reinvest with confidence.