The Basics
What Is a 1031 Exchange?
It is the single most powerful tax tool available to US real estate investors — and the entire thing hinges on never touching your own sale proceeds.
The short answer
How a 1031 exchange works
Ordinarily, selling an appreciated investment property triggers tax on the gain. Section 1031 of the Internal Revenue Code creates an exception: if you reinvest the proceeds into like-kind real property and follow a strict set of rules, the gain is deferred rather than recognized.
The mechanism that makes it work is the qualified intermediary. You are not allowed to take actual or constructive receipt of the sale proceeds at any point. The intermediary receives the money at closing, holds it, and applies it to your replacement purchase.
01Engage a qualified intermediary before you close
The exchange agreement must be signed before your relinquished property sale closes. If the proceeds reach you first, the exchange is over before it starts.
02Sell, and the proceeds go to the intermediary
At closing, the net proceeds wire directly from the closing agent to the intermediary — never to you. Day 1 of both deadline clocks starts here.
03Identify replacement property within 45 days
You have 45 calendar days to name your replacement property or properties in a signed written notice delivered to the intermediary. Weekends and holidays count.
04Close within 180 days
The intermediary applies your held funds to the purchase. The full 180-day window is also capped by your tax return due date, extensions included.
05Your basis carries over, and the tax is deferred
Your original cost basis follows you into the new property. The deferred gain is not forgiven — it comes due when you eventually sell without exchanging.
What a 1031 exchange actually saves you
The deferral covers four separate layers of tax, which is why the combined effect is so large:
| Tax | Typical rate | Applies to |
|---|---|---|
| Federal capital gains | 0% / 15% / 20% | Appreciation above your adjusted basis |
| Depreciation recapture | Up to 25% | Depreciation deductions you have already claimed |
| Net investment income tax | 3.8% | Higher-income taxpayers above the threshold |
| State capital gains | 0% – 13.3% | Varies widely; several states impose none |
On a $2,000,000 sale with a $900,000 gain, a combined 30% rate is $270,000 of tax. Deferring it keeps that entire amount working in the next property instead of leaving for the IRS.
The four types of 1031 exchange
| Type | How it works | When to use it |
|---|---|---|
| Forward (delayed) | Sell first, then buy within the 45/180-day windows. The standard case, and roughly 90% of exchanges. | Almost always, when timing allows. |
| Reverse | Buy the replacement first; an Exchange Accommodation Titleholder holds title until you sell. | When you must secure the replacement property before your sale can close. |
| Improvement / construction | Exchange funds are used to build on or improve the replacement property before you take title. | When the replacement property needs work to reach equal-or-greater value. |
| Simultaneous | Both closings happen the same day. | Rare — requires perfectly aligned timing on both sides. |
What qualifies, and what does not
Qualifies
- Rental houses, condos and small multifamily
- Apartment buildings and commercial property
- Retail, industrial, office and self-storage
- Raw land held for investment
- Farm and ranch land
- Fractional interests such as Delaware Statutory Trusts and tenant-in-common interests
Does not qualify
- Your primary residence
- Property held primarily for resale, such as a fix-and-flip
- Stocks, bonds, partnership interests and notes
- Personal property of any kind — eliminated from Section 1031 by the 2017 Tax Cuts and Jobs Act
- Property located outside the United States
Boot: the part that catches people out
To defer the whole gain you must buy replacement property of equal or greater value, reinvest all the net proceeds, and replace any debt that was paid off. Anything left over is “boot” and is taxable up to the amount of your gain.
Boot comes in two forms:
- Cash boot — proceeds you keep rather than reinvest.
- Mortgage boot — a reduction in your debt. If you paid off a $500,000 mortgage and take on only $300,000 on the replacement, the $200,000 difference is boot unless you cover it with additional cash.
A partial exchange is still worthwhile. Boot is taxable only up to your realized gain, and everything you do reinvest stays deferred.
1031 Basics
1031 exchange FAQs
What is a 1031 exchange?
A 1031 exchange, named for Section 1031 of the Internal Revenue Code, lets a real estate investor sell an investment or business property and reinvest the entire proceeds into another like-kind property without recognizing capital gains tax at the time of sale. A qualified intermediary holds the proceeds between the two closings so the investor never takes receipt of the funds.
What property qualifies for a 1031 exchange?
Real property held for productive use in a trade or business or for investment. Since the 2017 Tax Cuts and Jobs Act, only real property qualifies — personal property exchanges were eliminated. Your primary residence does not qualify. Property held primarily for resale, such as a fix-and-flip, generally does not qualify either.
What does like-kind mean in a 1031 exchange?
For real estate, like-kind is interpreted very broadly: nearly any US investment real property can be exchanged for nearly any other. An apartment building can be exchanged for raw land, a retail strip for a warehouse, or a rental condo for a share of a Delaware Statutory Trust. What matters is that both properties are real property held for investment or business use, and both are located in the United States.
How much tax does a 1031 exchange defer?
Four layers: federal capital gains tax at 0%, 15% or 20% depending on income; depreciation recapture at up to 25% on the depreciation you have claimed; the 3.8% net investment income tax if applicable; and state capital gains tax, which ranges from 0% to over 13%. For many investors the combined rate lands between 25% and 40% of the gain.
Do I have to reinvest all the proceeds?
To defer the entire gain, yes. You must acquire replacement property of equal or greater value, reinvest all the net proceeds, and replace any debt that was paid off — with new debt or additional cash. Anything you keep, whether cash or debt relief, is called boot and is taxable up to the amount of your gain.
How many times can I do a 1031 exchange?
There is no limit. Investors routinely chain exchanges for decades, deferring gain each time. Under current law, if the property is still held at death, the heirs receive a stepped-up basis to fair market value and the deferred gain is effectively eliminated — the reason the strategy is sometimes described as swap till you drop.
What is a reverse 1031 exchange?
A reverse exchange is when you acquire the replacement property before selling the relinquished one. Because you cannot hold title to both simultaneously and still qualify, an Exchange Accommodation Titleholder holds title to one of the properties in the interim. Reverse exchanges are more complex and typically cost $4,000 to $7,500 or more.
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