Introduction
For real estate investors, capital gains taxes on a property sale can be a heavy burden. But there’s a powerful tool under U.S. tax law—Section 1031—that lets you defer those taxes when structured properly. A 1031 exchange (often called a “like-kind exchange”) allows you to sell an investment property and reinvest the proceeds into another qualifying property, postponing the tax hit.
In this blog, we’ll walk through the basics, key rules, strategies, risks, and when a 1031 makes sense (or doesn’t).
What Is a 1031 Exchange?
- Under IRC §1031, when you exchange one “like-kind” property held for business or investment for another, you can defer recognition of capital gains (and some depreciation recapture) at the time of the exchange. Wikipedia+2Raymond James+2
- The tax isn’t erased—it’s deferred. At some future sale (without another 1031), your deferred gain becomes taxable.
- Post-2017 changes limit 1031 exchanges to real property only; personal property no longer qualifies. Investopedia+1
- You don’t need to exchange identical property (e.g. apartment building → commercial building is okay) as long as both are used for business or investment. Raymond James+2RMP Law+2
Key Rules & Deadlines
A 1031 exchange isn’t just “sell and buy another”; it comes with strict rules:
- Qualified Intermediary (QI)
You cannot touch the cash from the sale yourself. A QI “holds” the funds between the sale of the relinquished property and purchase of the replacement property. Trying to control the funds breaks the rules. Lane, Lane & Kelly+2RMP Law+2 - 45-Day Identification Window
From the date you close on the property you are selling, you have 45 days to identify (in writing) potential replacement property(ies). Wikipedia+2Raymond James+2 - 180-Day Exchange Period
You must close on the replacement property within 180 days of the initial sale (or by your tax return due date, if earlier). Wikipedia+2Raymond James+2 - Equal or Greater Value & No “Boot”
To fully defer tax, the replacement property’s net value (and mortgage load) generally must be equal or higher. If you receive leftover cash (“boot”), that portion can be taxable. Wikipedia+2Lane, Lane & Kelly+2 - Same Taxpayer Rule
The entity selling the relinquished property must be the same as the one acquiring the replacement property. RMP Law+1 - Reporting
Use IRS Form 8824 to report the exchange when you file your tax return. Lane, Lane & Kelly+1 - Clawback / Depreciation Recapture
Even though you’re deferring, depreciation you claimed may still need to be recaptured later.
Strategies & Structures
Here are some tactics investors use around 1031:
- “Swap up” or consolidate – Sell a smaller property and reinvest into a larger one, or vice versa.
- Multiple properties – You can identify up to 3 replacement properties (or use a 200% rule), though closing on all is not mandatory. Raymond James+1
- Reverse exchanges – Acquire the new property first, then dispose of the old one (more complex).
- Improvement (build) exchanges – Use proceeds to improve or build on the replacement property, under stricter controls.
- DSTs / Delaware Statutory Trusts – Instead of acquiring a physical property, invest in a DST (which can act as a replacement property) to gain passive ownership while still satisfying 1031 rules. Realized 1031+2Lane, Lane & Kelly+2
- UPREIT / 721 – A 721 exchange is different but related: exchange property into a REIT structure to get deferred gain benefits. Accruit
Pros & Trade-Offs
Pros:
- Defers taxes, allowing more capital to stay invested.
- Enables portfolio growth or rebalancing.
- Helps “ladder” property transitions, e.g. moving into lower-maintenance or higher-yield assets.
- Could be part of estate planning strategies. Lane, Lane & Kelly+1
Trade-offs / Risks:
- Complexity and strict deadlines – missing a date kills the deferral.
- Liquidity constraint – you must reinvest fully.
- Market risk – replacement property might underperform.
- Transaction costs, holding costs, and intermediary fees.
- Future tax law changes (Congress could restrict/eliminate 1031).
- Basis adjustments – your “new” basis carries over, so your eventual tax burden may still be large when sold outright.
When 1031 Makes Sense (or Not)
Good use cases:
- You’re “trapped” in a property with large gains and want to upgrade or relocate your investment.
- You want to consolidate multiple properties into one, or diversify one into multiple.
- You prefer passive or lower-maintenance ownership (e.g. via DSTs).
When it may not be ideal:
- You want to cash out now and don’t care about deferring taxes.
- Your replacement properties are hard to source (esp. under tight real estate markets).
- The incremental value from the deferral doesn’t justify the risk/complexity.
- You are near death or likely to pass the property to heirs (because heirs often get a stepped-up basis).
Bottom Line & Tips
If done carefully, a 1031 exchange is a powerful tool in a real estate investor’s toolkit. But its success depends heavily on timing, structure, and due diligence. Always engage experienced tax, legal, and real estate professionals before entering a 1031.
Some tips:
- Start planning early (don’t wait until the last minute).
- Use reputable qualified intermediaries with strong compliance records.
- Be conservative in identifying replacement properties (some may fall through).
- Monitor state-level rules — some states have “clawback” or own tax treatment for exchanges.
- Keep good documentation of values, appraisals, and transactions.