A 1031 exchange is a transaction under Section 1031 of the Internal Revenue Code that lets you sell one piece of investment or business real estate and buy another without paying capital gains tax at the time of the swap.1Section 1031 of the Internal Revenue Code The tax doesn’t disappear. It gets postponed by rolling your existing tax basis into the replacement property, so the gain sits dormant until you eventually sell for cash. With long-term capital gains rates running from 0% to 20% depending on income, plus a possible 3.8% net investment income tax for high earners, the deferral can free up serious capital to keep working for you.
How the Deferral Works
A 1031 exchange is a postponement, not a forgiveness. The mechanism is basis carryover. When you sell a property and buy a replacement through a properly structured exchange, your original tax basis moves to the new property.
Say you bought a building for $200,000, claimed $50,000 in depreciation, then exchanged it for a property worth $400,000. Your basis in the replacement is $150,000, not $400,000. The $250,000 gap between that basis and the property’s value is deferred gain, waiting to be taxed the day you sell the replacement for cash.
The statute puts it plainly: the basis of replacement property in a like-kind exchange equals the basis of the property given up, adjusted for any cash received and any gain recognized in the exchange. Debt the other party assumes counts as cash received for this calculation.
Because depreciation on the replacement property starts from that carried-over basis rather than the new purchase price, your deductions going forward are smaller than they would be after an ordinary purchase. Investors who chain exchanges together over decades build portfolios with substantial embedded tax liability and equally substantial compounding, since the capital that would have gone to taxes stays invested.
What Property Qualifies
Since the Tax Cuts and Jobs Act took effect for exchanges after December 31, 2017, Section 1031 covers real property only. Personal property like equipment, vehicles, and artwork no longer qualifies. Both the property you give up and the property you receive must be held for productive use in a trade or business or for investment.
The “like-kind” standard is broader than most people expect. It refers to the nature of the property — real estate for real estate — not its specific type. A warehouse can be exchanged for an apartment building. Raw land can be exchanged for a commercial office. A ranch qualifies against a downtown retail space. The category is what matters, not the resemblance.
Several types of real property are excluded:
- Property held primarily for sale, such as the homes a developer builds as inventory.
- Personal residences, because they aren’t held for business or investment use.
- Foreign real property, which is not considered like-kind to U.S. real estate. You can trade one U.S. property for another, or one foreign property for another, but not across the border.
The 45-Day and 180-Day Deadlines
Two deadlines control the entire exchange, and missing either one kills the deferral. Both run from the day you transfer the relinquished property.
- 45 days to identify replacement property. You must deliver a signed, written identification of the property or properties you intend to acquire. The document needs a legal description or unambiguous street address, and it goes to the qualified intermediary or another party in the exchange (not a disqualified person, like your own attorney).
- 180 days to close. You must actually receive the replacement property within 180 days of the transfer, or by the due date of your tax return (including extensions) for the year the exchange started, whichever comes first. If your return is due April 15 and that falls before day 180, file for an extension or you’ll lose the exchange.
These are calendar days, and they run concurrently. The 45-day window sits inside the 180-day window. There are no extensions for slow financing, cold feet, or a thin market. The one recognized exception involves federally declared disasters, where Revenue Procedure 2018-58 allows affected taxpayers to push both deadlines to the later of the last day of the IRS disaster relief period or 120 days from the original deadline.
Identification Rules
You cannot use the 45-day window to list every property on the market. Three rules cap what you can identify:
- Three-property rule. You may identify up to three replacement properties regardless of their value. This is the option most exchangers use.
- 200% rule. You may identify any number of properties as long as their combined fair market value doesn’t exceed twice the value of the property you gave up. Sell a $500,000 property and you can identify up to $1,000,000 worth of candidates.
- 95% rule. You may identify an unlimited number of properties without any value cap, but you must actually acquire at least 95% of the total value you identified. Miss the threshold and the whole identification fails.
The 95% rule is rarely used because the consequences of falling short are severe. The 200% rule gives room to plan a split into several smaller properties. Most exchangers stick with the three-property rule.
The Qualified Intermediary
You cannot touch the sale proceeds at any point during the exchange. If you receive the money, or even have the legal right to demand it, the IRS treats the transaction as an ordinary taxable sale. This is the constructive receipt problem, and the solution is a qualified intermediary who holds the funds under a written exchange agreement that specifically restricts your access.
Not just anyone can serve. Treasury regulations disqualify anyone who has acted as your employee, attorney, accountant, investment banker or broker, or real estate agent or broker within the two years before the exchange. Someone who has only provided 1031 exchange services or routine financial, title, escrow, or trust services is not disqualified for those activities alone.
The intermediary receives the sale proceeds at closing, holds them in a separate account, then uses the funds to buy the replacement property on your behalf. You never appear in the chain of funds. The intermediary pays the seller of the replacement property, and the settlement agent transfers the deed to you.
Protecting Your Funds
Exchange funds held by a qualified intermediary are not automatically protected if the intermediary goes bankrupt. In at least one major case, exchangers whose funds were held by LandAmerica 1031 Exchange Services were treated as general unsecured creditors in bankruptcy and faced significant losses. The exchange agreement language decided whether the funds were held in trust or simply owed as a debt.
No federal law requires intermediaries to carry fidelity bonds or errors-and-omissions insurance, though some states impose requirements. Before signing an exchange agreement, insist that your funds be held in a segregated qualified escrow account or qualified trust rather than commingled with the intermediary’s operating funds. Ask about fidelity bond coverage and errors-and-omissions insurance. A reputable intermediary will provide proof without hesitation.
When Part of the Exchange Is Taxable: Boot
Most exchanges are not perfectly clean swaps of equal-value properties. When you receive cash, personal property, or net debt relief as part of the deal, that non-like-kind value is called “boot,” and it triggers taxable gain. The gain you recognize equals the boot you receive, but it can never exceed the total gain you realized on the exchange.
Boot shows up in two common forms. Cash boot is straightforward: sell for $500,000 and reinvest only $450,000, and the $50,000 you kept is taxable. Mortgage boot is less obvious. If the mortgage on your old property was $300,000 but you take on only $200,000 in debt on the replacement, the $100,000 of debt relief is treated as money received. It’s taxable unless you offset it by adding $100,000 of your own cash to the deal.
Receiving boot doesn’t blow up the whole exchange. You get partial deferral on the qualifying portion and pay tax only on the boot. But you cannot deduct any loss on a partially like-kind exchange. If boot is involved, gains get recognized and losses do not.
The safest approach is to trade equal or up in both equity and debt. Reinvest all proceeds through the intermediary, take on at least as much debt as before, and don’t pocket any cash from the closing table.
Variations: Reverse, Improvement, and Related-Party Exchanges
The standard 1031 works forward: sell first, buy second. Several variations handle situations that don’t fit that pattern.
Reverse exchanges come into play when the replacement property surfaces before you’ve sold your current one. An Exchange Accommodation Titleholder acquires and holds the replacement property while you work on selling the relinquished property. Revenue Procedure 2000-37 provides a safe harbor. Within five business days of the transfer to the titleholder, you and the titleholder must sign a written Qualified Exchange Accommodation Arrangement acknowledging the property is being held to facilitate a 1031 exchange. You then have 45 days to formally identify either the replacement or relinquished property in writing, and the entire exchange must wrap up within 180 days. The combined time either property sits in the parking arrangement cannot exceed 180 days.
Improvement exchanges (sometimes called build-to-suit exchanges) let exchange funds pay for construction or renovation on the replacement property while the titleholder holds it. Only improvements physically in place when you take title count as like-kind property. Prepaid materials sitting in a warehouse or contracted labor not yet performed don’t qualify. Exchange funds left unspent at the 180-day deadline become boot and taxable. The completed replacement property must be worth at least as much as the relinquished property for full deferral.
Related-party exchanges are allowed but carry a two-year holding rule. If either you or the related party disposes of the exchanged property within two years, the deferred gain becomes taxable as of the date of that disposition. The statute defines “related person” broadly, drawing on the attribution rules of Sections 267(b) and 707(b)(1), so it captures family members, entities you significantly own, and various other relationships. Three exceptions soften the rule: dispositions caused by death, involuntary conversions such as condemnation or natural disaster, and transactions where you can show the IRS that neither the exchange nor the later sale was motivated by tax avoidance.
Vacation Homes and Mixed-Use Properties
A property you use partly for rental income and partly for personal vacations sits in a gray area. Revenue Procedure 2008-16 provides a safe harbor: the IRS won’t challenge a vacation home exchange if the relinquished property was owned for at least two years, rented at fair market value for at least 14 days in each of those years, and your personal use didn’t exceed 14 days or 10% of the rental days (whichever is greater) in each year. The replacement property must meet the same rental and personal-use limits for the two years after the exchange.
If you live in part of a property and use the rest for business or investment, such as a duplex where you occupy one unit and rent the other, you can potentially combine the Section 121 home-sale exclusion with a 1031 exchange. The residential portion may qualify for the $250,000 gain exclusion ($500,000 if married filing jointly) under Section 121, provided you lived there for at least 24 of the 60 months before the sale. The investment portion qualifies for 1031 treatment. You’ll need to allocate the sale price between the two uses with reasonable documentation.
The Estate Planning Payoff
This is where a 1031 exchange becomes genuinely powerful rather than just useful. Under Section 1014, property inherited from someone who has died generally receives a basis equal to its fair market value on the date of death. If you spend 30 years doing sequential 1031 exchanges, building a portfolio with millions in deferred gain and a tiny carried-over basis, and then you die, your heirs inherit the property at its current market value. The deferred gain is wiped out. It’s never taxed.
This “swap till you drop” strategy is one of the most significant tax-planning tools available to real estate investors. A deferral that starts as a timing advantage becomes a permanent elimination if you hold until death. Whether Congress will eventually close the interaction between Sections 1031 and 1014 is an open question. As of 2026, it remains intact.
Reporting and Record-Keeping
Every like-kind exchange gets reported on IRS Form 8824, attached to your federal tax return for the year the exchange occurred. The form asks for descriptions of both properties, the dates of identification and acquisition, the adjusted basis of the property given up, the fair market value of the property received, and any boot involved.
Record retention is where the rules bite in a way many exchangers underestimate. Because your basis in the replacement property carries over from the original property, you must keep records on both properties until the statute of limitations expires for the tax year in which you finally dispose of the replacement property in a taxable sale. Chain exchanges across 20 years and you need records from the original purchase. Losing those records can leave you unable to prove your basis, which could result in the IRS taxing the entire sale price as gain.
Keep copies of all exchange agreements, identification notices, closing statements, qualified intermediary contracts, and depreciation schedules. Store them as if they’ll matter for decades, because they will.