A 1031 exchange lets you sell an investment or business real estate property and roll the proceeds into another one without paying capital gains tax at the time of sale, but the 1031 exchange rules and deadlines are strict: both properties must be real estate held for investment or productive use, the money must move through a qualified intermediary rather than your hands, you have 45 days from the sale to identify replacement property in writing, and you have 180 days from the sale to close on it.
The 45-Day and 180-Day Deadlines
Two clocks start the moment you close on the sale of the property you’re giving up, and missing either one kills the deferral.
The 45-day identification period requires you to give your qualified intermediary a signed, written list of potential replacement properties before midnight on the 45th day. The 180-day exchange period requires you to close on the replacement within 180 calendar days of that same sale. The two periods run concurrently; the 180-day clock does not restart when the 45-day window ends.1eCFR. 26 CFR 1.1031(k)-1 – Treatment of Deferred Exchanges
One deadline catches people off guard: if your tax return is due before day 180, the exchange must close by the filing date unless you file an extension. Someone who sells in late November and files a return in mid-April may lose weeks off the back end of the 180 without realizing it.
The IRS does grant deadline relief in federally declared disaster areas, postponing various tax deadlines including 1031 exchange windows. Whether you qualify depends on whether you are an affected taxpayer under FEMA’s declaration for your area.2Internal Revenue Service. Tax Relief in Disaster Situations
How to Identify Replacement Properties
The written identification must follow one of three rules.1eCFR. 26 CFR 1.1031(k)-1 – Treatment of Deferred Exchanges
Most investors use the three-property rule, which lets you identify up to three potential replacement properties regardless of their combined value. If you want to identify more than three, the 200-percent rule applies: you can name any number of properties as long as their total fair market value doesn’t exceed twice the value of the property you sold. Fall outside both limits and you trigger the 95-percent rule, which requires you to actually acquire at least 95% of the aggregate value of everything you identified. In practice the 95-percent rule is a trap. Almost no one can guarantee they’ll close on that much of what they listed.
What Property Qualifies
Both the property you give up and the one you receive must be real property held for investment or productive use in a business.3Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment “Like-kind” refers to the nature of the property, not its quality or specific use, so a single-family rental qualifies as like-kind to an apartment complex, a commercial warehouse, or vacant land.4Internal Revenue Service. Like-Kind Exchanges Under IRC Section 1031
Before 2018, Section 1031 covered personal property too. The Tax Cuts and Jobs Act eliminated that. Today, only real property qualifies. Machinery, corporate jets, collectibles, and intellectual property are all out.5Internal Revenue Service. Like-Kind Exchanges – Real Estate Tax Tips
Several categories of real estate also fail the test. Your primary residence doesn’t qualify because you hold it for personal use. Homes a developer builds for immediate resale count as inventory, which is excluded. And domestic property cannot be exchanged for foreign property; the statute treats them as different classes entirely.6Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment – Section (h)
The Qualified Intermediary Requirement
You cannot touch the sale proceeds and still claim the deferral. The exchange hinges on routing the money through a qualified intermediary, a neutral third party who holds the funds between the sale of your old property and the purchase of the new one. If you take constructive receipt of the cash at any point, the IRS treats the transaction as a taxable sale.7Internal Revenue Service. Sales Trades Exchanges
Not just anyone can serve as your intermediary. Federal regulations disqualify anyone who has been your employee, attorney, accountant, investment banker, broker, or real estate agent at any point during the two years before the exchange. The only exception is someone whose prior work for you was limited to facilitating previous 1031 exchanges, or who provided routine title, escrow, or banking services.1eCFR. 26 CFR 1.1031(k)-1 – Treatment of Deferred Exchanges Your CPA or the real estate agent who listed the property cannot double as the intermediary.
Fees for a straightforward exchange typically run $500 to $1,500. Reverse exchanges and multi-property deals cost more. Before hiring anyone, ask whether they hold your funds in a segregated account identified by your name and tax ID number, whether they carry errors-and-omissions insurance, and whether they have a fidelity bond covering employee dishonesty. There is no federal licensing requirement for qualified intermediaries, so vetting is on you.
Avoiding Boot
To defer the entire gain, the replacement property’s purchase price and its debt must both match or exceed the sale price and debt on the old one. Any shortfall is called “boot” and is taxed immediately. The statute is blunt: gain is recognized up to the amount of money and the fair market value of non-like-kind property you receive.8Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment – Section (b)
Boot shows up in two common forms:
- Cash boot is any sale proceeds you don’t reinvest in the replacement. If your old building sells for $500,000 and you buy a replacement for $450,000, the leftover $50,000 is taxable.
- Mortgage boot is net debt relief. Selling a property with a $300,000 loan and buying one with a $200,000 loan creates $100,000 of mortgage boot.
You can offset mortgage boot by adding cash at closing. Bringing $100,000 of your own money into the purchase zeros out $100,000 of debt relief.
The Related-Party Two-Year Rule
Exchanging with a family member, a business you control, or another related party under IRS definitions triggers an extra rule. If either party disposes of the property they received within two years of the exchange, the deferred gain snaps back and becomes taxable in the year of that disposition.9Internal Revenue Service. Revenue Ruling 2002-83 Related parties include siblings, spouses, ancestors, lineal descendants, and entities where the taxpayer owns more than 50%.
Even if you satisfy the two-year hold, the IRS can still deny the deferral if it determines the exchange was structured to circumvent the related-party rules.
Reverse and Improvement Exchanges
Sometimes the replacement property comes along before you’ve sold the old one. Revenue Procedure 2000-37 provides a safe harbor for these reverse exchanges. An exchange accommodation titleholder, a third-party entity similar to a qualified intermediary, takes legal title to either the replacement property or the property you haven’t sold yet and parks it. You then have 180 days to complete the exchange by selling the relinquished property.10Internal Revenue Service. Revenue Procedure 2000-37 Miss that window and the safe harbor disappears.
Improvement exchanges work similarly. You park the replacement property with an exchange accommodation titleholder, who oversees construction or renovation. All improvements must be physically installed on the property; materials sitting in the driveway don’t count. Work must be completed while the titleholder holds the deed, and any construction finished after the 180th day doesn’t count toward the exchange value.
Both structures cost several times more than a standard forward exchange because they require a separate entity to hold title.
Reporting on Form 8824
Every 1031 exchange must be reported on IRS Form 8824, filed with your tax return for the year the exchange began. If you sold the relinquished property in December and closed on the replacement in February, the exchange is reported on the return for the year of the first transfer.11Internal Revenue Service. Instructions for Form 8824 The form captures the dates of each transfer, descriptions of both properties, the adjusted basis of the old property, and the fair market value of the new one.12Internal Revenue Service. Form 8824 – Like-Kind Exchanges
Any boot must be reported as recognized gain on the same return. If the IRS later determines the exchange didn’t meet statutory requirements, you’ll owe the original capital gains tax plus interest calculated from the date of the initial sale.
State Rules May Differ
Federal deferral under Section 1031 doesn’t automatically mean your state follows suit. Most states with an income tax conform to the federal rules, but some impose their own withholding requirements or reporting obligations, particularly when the replacement property is in a different state than the one you sold. A handful of states have clawback provisions that can tax the deferred gain if you later move out of the state where the original property was located. Investors exchanging across state lines should confirm the tax treatment in both states before closing.