A Section 1031 like-kind exchange allows a real estate investor to defer capital gains tax on the sale of investment or business property by reinvesting the proceeds into another qualifying property. Done correctly, 100% of the gain can be deferred - potentially indefinitely. Done incorrectly, the exchange fails and the full gain becomes taxable in the year of sale.
The Tax Cuts and Jobs Act (2017) limited §1031 exchanges to real property only, effective January 1, 2018. Vehicles, equipment, aircraft, artwork, collectibles, and other tangible personal property no longer qualify. OBBBA (P.L. 119-21) made no changes to this restriction. Only real property held for productive use in a trade or business or for investment qualifies. IRC §1031(a)(1); IRC §1031(h).
All four must be satisfied for a valid §1031 exchange:
| Requirement | Rule | Authority |
|---|---|---|
| Qualifying property | Real property held for investment or business use. Primary residences do not qualify (unless mixed use). IRC §1031(a)(1). | IRC §1031(a)(1); (h)(1) |
| Like-kind property | Replacement property must be real property. Any US real property is like-kind to any other US real property - an apartment building is like-kind to raw land, a commercial building to a single-family rental. Foreign property is only like-kind to other foreign property. IRC §1031(h)(2). | IRC §1031(a)(1); Treas. Reg. §1.1031(a)-1(b) |
| 45-day identification | Replacement property must be formally identified in writing within 45 days of closing on the relinquished property. No exceptions. If you miss the 45-day deadline, the exchange fails. | IRC §1031(a)(3)(A); Treas. Reg. §1.1031(k)-1(b) |
| 180-day closing | Replacement property must be acquired by the earlier of: 180 days after closing on the relinquished property, or the due date of your tax return (including extensions) for the year of the exchange. File an extension if necessary to preserve the full 180 days. | IRC §1031(a)(3)(B); Treas. Reg. §1.1031(k)-1(b)(2) |
Boot is the portion of exchange proceeds not reinvested in like-kind property. Boot is taxable in the year of exchange up to the amount of realized gain. Boot can be cash (you receive cash out of escrow) or mortgage boot (the replacement property has a smaller loan than the relinquished property).
Depreciation previously claimed on the relinquished property is subject to recapture under IRC §1250, taxed at up to 25% ordinary income rates. §1031 defers the capital gain but does not eliminate depreciation recapture. The recaptured depreciation carries over into the replacement property's basis and will be subject to recapture again when the replacement property is eventually sold (unless another §1031 exchange is done).
A Qualified Intermediary (QI) is required for all delayed exchanges (where sale and purchase of replacement property do not happen simultaneously). The QI is an independent third party who holds the exchange proceeds, executes the exchange agreement, and transfers the funds to purchase the replacement property. The taxpayer cannot have actual or constructive receipt of the funds during the exchange period.
A reverse exchange allows you to acquire the replacement property before selling the relinquished property. The replacement property must be acquired through an Exchange Accommodation Titleholder (EAT) - typically an LLC controlled by the QI - who holds legal title until the relinquished property is sold. The same 45-day and 180-day rules apply, running from the date the EAT acquires the replacement property. Rev. Proc. 2000-37.
Allows exchange proceeds to be used for construction or improvements on the replacement property, provided the improvements are complete and the property is received with the enhanced value within the 180-day period. Improvements made after the 180-day deadline do not count toward satisfying the exchange. Treas. Reg. §1.1031(k)-1(e).
| Disqualifying Event | Result |
|---|---|
| Proceeds touch taxpayer's hands before exchange completes | Full gain recognized in year of sale |
| Identification not made by Day 45 | Exchange fails; full gain recognized |
| Replacement property not acquired by Day 180 | Exchange fails; full gain recognized |
| Replacement property is personal property (not real estate) | That property does not qualify; gain on that portion recognized |
| Primary residence (personal use) exchanged | Does not qualify; consider IRC §121 exclusion instead |
| Related party exchange and replacement property sold within 2 years | Gain on original exchange recognized at time of related party sale; IRC §1031(f) |
The adjusted basis of the replacement property equals: fair market value of the replacement property, minus the gain deferred in the exchange. This means the deferred gain reduces the tax basis - creating lower depreciation deductions going forward and higher gain on a future sale. The tax deferral is not elimination. When the replacement property is eventually sold in a taxable transaction (not another §1031), all deferred gains from prior exchanges become taxable at that time. IRC §1031(d).