A 1031 exchange is a provision under Section 1031 of the Internal Revenue Code that lets a real estate investor defer capital gains taxes by reinvesting the proceeds from a sale into another investment property. The tax code treats the transaction as a continuation of the original investment rather than a taxable event, so the old property’s basis carries over to the new one and the full equity keeps working instead of shrinking by 15% to 23.8% in federal taxes.1Internal Revenue Service. Like-Kind Exchanges – Real Estate Tax Tips The rules are unforgiving. A single missed deadline or a stray dollar landing in the wrong account can turn the entire sale into a taxable event.
What Property Qualifies
Since the Tax Cuts and Jobs Act took effect in 2018, Section 1031 applies exclusively to real property. Equipment, vehicles, artwork, patents, and other personal or intangible assets no longer qualify.1Internal Revenue Service. Like-Kind Exchanges – Real Estate Tax Tips
The real estate itself must be held for productive use in a business or as an investment. A primary residence does not qualify because it is a personal-use asset, and properties held primarily for resale, like fix-and-flip inventory, are also excluded.2Office of the Law Revision Counsel. 26 U.S. Code 1031 – Exchange of Real Property Held for Productive Use or Investment
Within the real estate category, the IRS reads “like kind” broadly. An apartment building can be swapped for raw land, a retail strip center for an office building, a single rental house for a triple-net-leased warehouse. The two properties do not need to share a use, only an asset class: U.S. real property held for investment or business.
One hard boundary. Domestic and foreign real estate are not like kind to each other. A rental in Texas cannot be exchanged for a villa in Mexico.3Office of the Law Revision Counsel. 26 U.S.C. 1031 – Exchange of Property Held for Productive Use or Investment
The Two Deadlines That Control Everything
Two clocks start on the day you close the sale of the relinquished property. Miss either and the gain becomes taxable.
45 Days to Identify Replacement Property
Within 45 calendar days of the sale, you have to deliver a signed, written notice identifying potential replacement properties. The notice goes to someone involved in the exchange who is not a disqualified party, typically the qualified intermediary. Weekends and holidays count. There are no extensions.4Internal Revenue Service. Like-Kind Exchanges Under IRC Section 1031
Each property has to be described specifically enough to be identified, meaning a legal description or street address. Three rules cap how many you can list:
- Three-property rule: identify up to three replacement properties regardless of their combined value.
- 200% rule: identify more than three as long as their total fair market value does not exceed 200% of what you sold.
- 95% exception: if you go over both limits, the exchange still works only if you actually close on at least 95% of the aggregate value of everything identified. Most investors avoid this route because the margin for error is nearly zero.
A defective identification on day 45 kills the exchange. No late corrections, no amended lists.
180 Days to Close
You must close on the replacement property within 180 calendar days of the original sale, or by the due date (with extensions) of your income tax return for that year, whichever comes first.4Internal Revenue Service. Like-Kind Exchanges Under IRC Section 1031 That parenthetical about extensions matters. If you sell in January and your regular return is due April 15, the filing deadline would arrive well before day 180. Filing a tax extension pushes the due date to October 15 and preserves the full 180 days. Because many exchanges would otherwise expire early, filing an extension is standard practice for any sale that closes between October and April.
File the return before the exchange closes and the IRS treats the sale as a completed taxable event. There is no way to amend back into deferral after that.
Why You Need a Qualified Intermediary
You cannot touch the sale proceeds at any point during the exchange. A qualified intermediary holds the funds from the day the relinquished property closes until they are used to purchase the replacement. If the cash lands in your account even briefly, the IRS calls it constructive receipt and the deferral is gone.4Internal Revenue Service. Like-Kind Exchanges Under IRC Section 1031
Not everyone can serve as the intermediary. Anyone who has been your employee, attorney, accountant, investment banker, or real estate agent within the two years before the sale is a disqualified person. The rule exists to keep the intermediary independent rather than an extension of the taxpayer.
Fees for a standard delayed exchange typically run $600 to $1,200. More complex transactions such as reverse exchanges, improvement exchanges, or multi-property deals range from $3,000 to $8,500, plus smaller costs for wires, notaries, and overnight delivery.
Boot: When You Still Owe Tax
Cash or non-like-kind property received during a 1031 exchange is called boot. Boot is taxable, though only up to the amount of gain realized on the sale.4Internal Revenue Service. Like-Kind Exchanges Under IRC Section 1031
Boot appears in two common forms. Cash boot is straightforward: you sell for more than you reinvest, and the leftover cash is taxable. Mortgage boot catches more people off guard. If the old property carried a $400,000 mortgage and the replacement carries only $300,000, that $100,000 of debt relief is treated as boot. The IRS treats a drop in debt the same way it treats cash in hand. To get a full deferral, both the sale price and the debt level need to match or exceed the relinquished property.
What You Are Actually Deferring
The tax bill being pushed forward is larger than many investors realize, which is why the strategy carries so much weight on high-value real estate.
Federal Capital Gains Tax
Long-term capital gains on real estate held more than a year are taxed at 0%, 15%, or 20% depending on taxable income. For 2026, the 20% rate begins at $545,501 for single filers and $613,701 for married couples filing jointly.5Internal Revenue Service. Topic No. 409, Capital Gains and Losses Most investors with enough equity to justify a 1031 exchange sit in the 15% or 20% bracket.
Net Investment Income Tax
An additional 3.8% net investment income tax applies to gains from investment real estate when modified adjusted gross income exceeds $200,000 for single filers or $250,000 for married joint filers. Those thresholds are not indexed for inflation, so they reach more taxpayers each year.6Internal Revenue Service. Questions and Answers on the Net Investment Income Tax Combined, a high-income investor can face a 23.8% federal rate on the capital gain portion alone.
Depreciation Recapture
Depreciation deductions taken over the years come with a price at sale. Unrecaptured Section 1250 gain, the portion of profit attributable to prior depreciation, is taxed at a maximum rate of 25%. A 1031 exchange defers this recapture along with the regular gain but does not erase it. The accumulated depreciation carries forward to the replacement property and comes due when you eventually sell without exchanging.
The Estate Planning Payoff
This is where 1031 exchanges turn into a generational strategy. Under Section 1014 of the tax code, when the owner dies the cost basis of the property resets to its fair market value on the date of death.7Office of the Law Revision Counsel. 26 U.S. Code 1014 – Basis of Property Acquired From a Decedent Every dollar of deferred gain accumulated through decades of exchanges disappears for the heirs, who inherit at current value and owe little or no capital gains tax if they sell soon after.
Consider an investor who bought a rental for $200,000 in 1995 and, through a chain of 1031 exchanges, now owns a commercial building worth $2 million. That $1.8 million of deferred gain has been compounding across properties. Selling outright could produce a federal tax bill above $400,000. Holding until death delivers a stepped-up basis of $2 million to the heirs and eliminates the deferred liability.
The result is a “swap till you drop” approach: continuous exchanges through the investor’s life, with the step-up at death wiping out the accumulated obligation. The strategy depends on Section 1014 staying intact, and proposed changes surface in Congress from time to time, so it is worth watching with a tax advisor.
Reporting the Exchange on Form 8824
Every 1031 exchange has to be reported on IRS Form 8824, filed with the federal return for the year the exchange began.8Internal Revenue Service. Instructions for Form 8824 (2025) The form asks for descriptions and addresses of both properties, the date the replacement was identified, the transfer dates, and the figures needed to calculate realized gain and the deferred portion.
Line 25 produces the adjusted basis of the replacement property, essentially the old basis carried forward and adjusted for boot received, closing costs, and intermediary fees. This number drives depreciation on the new property and the gain calculation on any future sale, so an error here creates incorrect depreciation schedules and potential underpayment penalties years later.8Internal Revenue Service. Instructions for Form 8824 (2025)
Keep the paperwork from every exchange: closing statements, intermediary agreements, identification letters, and depreciation schedules for each property in the chain. The IRS tracks deferred gains through successive exchanges, and when you eventually sell without reinvesting, you will need to reconstruct basis history back to the original property. Investors who lose those records often pay more tax than they owe because they cannot prove the adjusted basis.