How does a 1031 exchange work?
A 1031 exchange lets a real estate investor defer capital gains tax by selling one investment property and reinvesting the proceeds into another like-kind investment property. Named for IRC Section 1031, it defers — not eliminates — the tax, as long as strict rules on timing, a qualified intermediary, and reinvestment are followed.
What it actually does
When you sell an appreciated investment property outright, you owe tax on the gain — capital gains, depreciation recapture, and often state tax. A 1031 exchange lets you defer all of it by rolling the proceeds into a new like-kind investment property instead of cashing out.
Defer, not eliminate. The deferred gain carries forward into your new property’s basis. Keep exchanging over a lifetime — sometimes called “swap till you drop” — and heirs may receive a stepped-up basis at death, which can wipe the deferred gain entirely. But the moment you sell without exchanging, the accumulated tax comes due.
The five core requirements
- Investment or business property. The property must be held for investment or productive use in a trade or business — not a primary residence or a flip. (See what qualifies as like-kind.)
- Like-kind replacement. For real estate this is broad — almost any U.S. investment real property is like-kind to any other.
- A qualified intermediary (QI). You cannot touch the sale proceeds. A QI must hold them between the sale and the purchase — take possession of the money and the exchange is dead.
- The deadlines. 45 days to identify replacement property, 180 days to close. (See the 45- and 180-day rules.)
- Equal-or-greater reinvestment. To defer 100% of the tax, reinvest all your equity and replace your debt, with the replacement costing at least as much as the net sale price.
Watch out for “boot”
Any value you don’t reinvest becomes taxable boot — cash you pull out, or mortgage debt you reduce and don’t replace. Boot is taxed immediately, so model your loan balances, fees, and replacement values before committing.
A couple of important cautions
Since the 2017 tax law, 1031 applies to real property only — equipment and other personal property no longer qualify. And a related-party exchange (with family or an affiliated entity) generally requires both parties to hold their properties for at least two years, or the deferral unwinds. This is complex, deadline-driven tax territory — always work with a qualified intermediary and a tax advisor.