Capital gains: 1031 exchanges
1031 exchanges: deferring the gain on investment real estate
Section 1031 lets you sell investment real estate and roll the whole gain into replacement property without paying tax on it now. The rules are strict, the clocks are short, and almost every mistake is made before the sale closes.
The basics
What a 1031 exchange actually does
Normally, selling a property that has gone up in value triggers federal capital gains tax, depreciation recapture, and in most states a state tax on top. IRC Section 1031 says that when real property held for business or investment is exchanged for other real property held the same way, no gain is recognised at that point.
The word that matters is deferred. Your tax basis moves into the new property, so the gain is carried forward rather than forgiven. It comes due when you eventually sell in an ordinary taxable sale.
In practice almost every exchange today is a delayed exchange: you sell first, and buy the replacement within the deadlines below. A qualified intermediary holds the money in between, because the exchange fails the moment the proceeds become available to you.
- Real property only, on both sides, since 2018.
- Held for business or investment, not a home or a flip.
- Equal or greater value and debt to defer the whole gain.
The deadlines
Two clocks, and both start the day you close
These are statutory deadlines under IRC 1031(a)(3). They do not stop for weekends or holidays, and outside a federally declared disaster they cannot be extended.
Day 0
Sale closes
Both clocks start on the day you transfer the property you are giving up. They run at the same time, not one after the other.
Day 45
Identify in writing
Replacement property has to be identified in a signed writing delivered to a party to the exchange, usually the qualified intermediary. Midnight on day 45, no extensions.
Day 180
Acquire
The replacement has to be received by day 180, or by the due date of your return for that year if earlier. File an extension if the sale is late in the year.
Identification
How much you are allowed to identify
Within the 45 days you can name more than one candidate, which is how owners protect themselves against a purchase that falls through. The regulations limit how many.
| Rule | What it allows | Source |
|---|---|---|
| Three property rule | Identify up to three properties of any value. | Treas. Reg. 1.1031(k)-1(c)(4)(i)(A) |
| 200 percent rule | Identify any number of properties, as long as their combined fair market value is no more than twice the value of what you sold. | Treas. Reg. 1.1031(k)-1(c)(4)(i)(B) |
| 95 percent exception | Exceed both limits only if you then acquire at least 95 percent of the value of everything you identified. | Treas. Reg. 1.1031(k)-1(c)(4)(ii)(B) |
Where exchanges fail
Six ways an exchange is lost, and when each one happens
Touching the money
If you have actual or constructive receipt of the sale proceeds, the exchange fails. That is why a qualified intermediary holds them under Treas. Reg. 1.1031(k)-1(g)(4), and why the intermediary must be engaged before closing.
Trading down
Cash you keep and debt you are relieved of without replacing it are both taxable to the extent of your gain. To defer all of it, replace both the value and the debt.
A related party
An exchange with a related person can be undone if either side disposes of the property within two years, under IRC 1031(f).
The wrong property
Only real property held for business or investment qualifies on both sides. A primary residence, a property bought to flip, and since 2018 any personal property, do not.
A loose identification
An identification that is late, unsigned, vague about the property, or over the limits of the three property and 200 percent rules can disqualify the whole exchange.
Starting too late
None of the above can be fixed after closing. The structure has to exist on the day the sale funds.
Where we fit
The right exchange partner, before the clock starts
We hear you out first: what you are selling, the gain and the debt involved, your closing date, and what you want the money to do next. Then we connect you with a partner firm that works on 1031 exchanges and suits your situation and your timeline.
- The introduction happens early enough to plan the 45 day identification.
- The partner firm works alongside your qualified intermediary, CPA and attorney.
- If another approach on this site suits you better, we say so.
Questions
1031 exchange questions
Does a 1031 exchange eliminate the tax?
No. It defers it. Your old basis carries into the replacement property, so the gain is still there and is recognised when you eventually sell in a taxable sale. Exchanges can be repeated, and under IRC 1014 heirs generally take a basis stepped up to fair market value at death, which is why many owners hold through successive exchanges.
What property qualifies?
Real property held for productive use in a trade or business or for investment, exchanged for other real property held the same way. Since the 2017 tax act, personal property such as equipment and vehicles no longer qualifies. A primary residence and property held mainly for resale do not qualify.
Can I take some cash out?
Yes, but any cash you receive, and any debt relief you do not replace, is taxable to the extent of your gain. The rest of the gain can still be deferred.
Can a Delaware Statutory Trust interest be replacement property?
Yes, when the trust is structured within the limits of Revenue Ruling 2004-86. Owners often identify one as a backup alongside a direct purchase, because a DST interest can be sized to an exact dollar amount.
When should I call?
Before the sale closes, and ideally before you sign the purchase agreement. The qualified intermediary has to be in place before closing, and the 45 day clock leaves little room to start from nothing.