1031 Exchange Laws: Deadlines, Intermediary, and Boot Rules

The rules for a 1031 exchange let you sell investment or business real estate and roll the proceeds into another qualifying property while deferring the capital gains tax you would otherwise pay at closing. To make it work, both properties must be real property held for business or investment use, a qualified intermediary must hold the sale proceeds, and you must identify a replacement within 45 days and close within 180. Missing any of those conditions collapses the deferral and makes the full gain taxable in the year of sale.

What Property Qualifies

Section 1031 applies only to real property held for productive use in a trade or business, or for investment.¹ Since the Tax Cuts and Jobs Act took effect in 2018, personal property, equipment, and intangibles no longer qualify.²

The “like-kind” standard for real estate is broad. A strip mall can be exchanged for raw farmland. A single-family rental can be exchanged for a warehouse. The two properties don’t need to match in type; they just both need to be real property used in a trade, business, or investment.

A few boundaries matter because they catch people off guard:

Your primary residence does not qualify. It’s a personal-use asset, not investment property.¹
Real property held primarily for sale, such as a developer’s inventory of flips, is expressly excluded.¹
U.S. real estate and foreign real estate are not like-kind to each other. Selling an Arizona rental to buy a villa in Mexico will not defer the gain.¹

Vacation and Second Homes

Vacation properties sit in a gray zone. A beach house you rent out most of the year and rarely use may qualify; one you visit every weekend probably won’t. Revenue Procedure 2008-16 provides a safe harbor. For each of the two 12-month periods before the exchange (for the property you’re selling) or after it (for the replacement), the property must:³

Be rented to someone else at a fair rate for at least 14 days.
Have your personal use limited to the greater of 14 days or 10 percent of the days it was rented at fair market value.

You also need to own the property for at least 24 months on the relevant side of the exchange for the safe harbor to apply. Falling outside it doesn’t automatically disqualify the property, but it forces you into a less certain argument about investment intent.

The 45-Day and 180-Day Deadlines

Two deadlines control every exchange, and both clocks start the day you close on the sale of your relinquished property.¹

You have 45 calendar days to formally identify potential replacement properties in writing. Weekends, holidays, and natural disasters do not pause the clock.
You have 180 calendar days to close on the replacement property, or until the due date of your tax return for that year including extensions, whichever comes first.

The identification period is part of the 180 days, not on top of them. After you identify, you have roughly 135 days left to close. If your sale closes in early October, your tax return due date could arrive before day 180, so filing an extension is standard practice to preserve the full window.

How to Identify Replacement Property

The identification must be in writing, signed by you, and delivered to your qualified intermediary or another party involved in the exchange before day 45. Each property has to be described clearly enough to remove ambiguity, typically by legal description, street address, or a recognizable name.⁴

Treasury regulations give you three options for how many properties you can name:⁴

Three-property rule. Identify up to three replacements regardless of value. This is the most common approach.
200 percent rule. Identify more than three properties as long as their combined fair market value does not exceed 200 percent of what you sold.
95 percent rule. Identify any number at any value, but you must actually acquire at least 95 percent of the total value of everything identified. It’s a safety valve, not a planning tool.

The Qualified Intermediary Requirement

You cannot touch the sale proceeds. If you take actual or constructive receipt of the money, the exchange fails and the full gain becomes taxable.⁵ The way around this is a qualified intermediary, sometimes called an exchange facilitator, who holds the proceeds in escrow between the sale and the purchase.

Using an intermediary is not written into the statute as mandatory, but it is the primary IRS safe harbor against constructive receipt, and there is no reliable alternative for a standard deferred exchange.⁶ The intermediary must be independent. Anyone who has served as your real estate agent, attorney, accountant, broker, or employee within the previous two years is disqualified from the role.⁵

One risk worth knowing: the federal government does not regulate qualified intermediaries the way it regulates banks or brokerages. If your intermediary goes bankrupt while holding your funds, you can lose them. Insist that proceeds be held in a segregated qualified escrow or qualified trust account that is explicitly excluded from the intermediary’s general assets.

Boot: When Part of the Gain Becomes Taxable

When the replacement property doesn’t fully absorb the value of what you sold, the leftover is called boot, and it’s taxable. It usually shows up in one of two forms:

Cash boot. Sale proceeds you don’t reinvest. Sell for $500,000, buy for $450,000, and $50,000 is cash boot.
Mortgage boot. A drop in total debt. If you owed $300,000 on the old property and only take on $200,000 on the new one, that $100,000 of debt relief is mortgage boot.

The taxable gain you recognize is the lesser of your realized gain or the boot received. A $120,000 realized gain with $50,000 of boot means tax on $50,000; the rest stays deferred. Boot on property held longer than a year is generally taxed at long-term capital gains rates, and higher earners may owe the 3.8 percent net investment income tax on the recognized portion.

Which Closing Costs You Can Pay from Exchange Funds

Direct costs of the sale or purchase count as exchange expenses and don’t create boot. Real estate commissions, transfer taxes, recording fees, title company charges, and the intermediary’s fee all fit here. Paying them from exchange proceeds reduces the cash left over, which can shrink or eliminate boot.

Financing costs are different. Loan origination fees, points, mortgage insurance, and lender-required appraisals are treated as costs of obtaining financing rather than of acquiring property, and paying them from exchange funds is treated as receiving cash. A rough test: if the expense would exist even in an all-cash purchase, it’s probably an exchange expense; if it exists only because of the loan, it isn’t.

Basis Carryover and Depreciation Recapture

A 1031 exchange does not erase your tax liability. It embeds it in the replacement property through a reduced basis. The basis of your new property equals the basis of what you gave up, adjusted for any boot paid or received and any exchange expenses.⁵ Two consequences follow. Annual depreciation deductions are smaller because the basis is smaller. And when you eventually sell without exchanging again, all the deferred gain from every prior exchange in the chain comes due.

Depreciation recapture is the part most people forget. When you sell real property at a gain, the portion of the gain attributable to depreciation you previously claimed is taxed at a maximum rate of 25 percent, higher than the ordinary long-term capital gains rate.⁷ A 1031 exchange defers the recapture along with the rest of the gain, but it keeps accumulating across every exchange in the chain.

Reporting on Form 8824

Every exchange must be reported on IRS Form 8824, attached to your tax return for the year the exchange happens.⁸ The form asks for:

A description of both the relinquished and replacement properties.
The dates the original property was transferred and the replacement was identified and received.
The fair market value of the like-kind property received and any other property or cash included.
The adjusted basis of the property you gave up and the calculation of your realized and recognized gain.

The form walks the gain calculation line by line and produces the basis of your replacement property.⁹ Keep every document from the exchange, including the exchange agreement, identification notices, closing statements for both properties, and correspondence with your intermediary. The IRS can audit years later, and reconstructing the basis chain without paperwork is close to impossible.

Variations You May Run Into

Reverse Exchanges

If you find the replacement property before your current one sells, a reverse exchange lets an exchange accommodation titleholder “park” the new property while you work on selling the old. Revenue Procedure 2000-37 provides a safe harbor.¹⁰ The 45-day and 180-day deadlines still apply, running in reverse: you must identify the property to be relinquished within 45 days and close its sale within 180. Reverse exchanges are more expensive and harder to finance, because the titleholder, not the taxpayer, is on title while the arrangement runs.

Improvement Exchanges

An improvement or build-to-suit exchange lets you use exchange proceeds to construct or renovate the replacement property before you take title. The accommodation titleholder acquires the property and holds title while the work is done. To fully defer the gain, the value of the property plus improvements should equal or exceed what you sold. All construction has to be finished and title transferred to you within the 180-day window; anything built after you take title doesn’t count, and materials merely ordered or delivered don’t qualify unless they’ve actually been installed.

Related Party Exchanges

Exchanges between related parties are allowed with a two-year holding leash. If either party disposes of the property received within two years, the deferred gain snaps back into income for the year of the disposition.¹¹ Related parties include family members such as siblings, spouses, ancestors, and lineal descendants, along with entities in which the taxpayer holds more than 50 percent ownership. The IRS also applies an anti-abuse rule to transactions structured to sidestep the restriction, so the deferral can be denied even if the two-year period passes. Involuntary dispositions such as foreclosures, condemnations, or a party’s death are exceptions.

Converting the Replacement Into a Primary Residence

You can eventually move into a 1031 replacement property and later use the Section 121 exclusion of up to $250,000 of gain, or $500,000 for a married couple filing jointly, but the rules layer up. You need to satisfy Rev. Proc. 2008-16 for the replacement side: own it for 24 months after the exchange, rent it at fair market rates for at least 14 days in each 12-month period, and keep personal use below the limits described earlier.³ Section 121(d)(10) then requires that you own the home for at least five years after the exchange and use it as your primary residence for at least two of the five years before the sale. A typical path is to close on the replacement, rent it for two years, move in for three or more, then sell.

The Stepped-Up Basis Ending

The feature that turns deferral into potential permanent tax elimination is the stepped-up basis at death. Under Section 1014, when you die your heirs receive inherited property at its fair market value on the date of death, not at your carryover basis.¹² Layers of deferred gain accumulated across decades of exchanges disappear, and so does the accumulated depreciation recapture. Buy for $200,000, exchange up to $1.2 million, die holding it, and the heirs’ basis resets to $1.2 million. It’s why many investors adopt what practitioners call a swap-till-you-drop approach, never intending to trigger a taxable sale during their lifetime.

1
Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment
2
Internal Revenue Service. Like-Kind Exchanges – Real Estate Tax Tips
3
Internal Revenue Service. Revenue Procedure 2008-16
4
eCFR. 26 CFR 1.1031(k)-1 – Treatment of Deferred Exchanges
5
Internal Revenue Service. Like-Kind Exchanges Under IRC Section 1031
6
Internal Revenue Service. Sales, Trades, Exchanges
7
Office of the Law Revision Counsel. 26 USC 1250 – Gain From Dispositions of Certain Depreciable Realty
8
Internal Revenue Service. Instructions for Form 8824
9
Internal Revenue Service. Form 8824 – Like-Kind Exchanges
10
Internal Revenue Service. Revenue Procedure 2000-37
11
Internal Revenue Service. Revenue Ruling 2002-83
12
Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent