Tax Strategy
What Is a 1031 Exchange in Real Estate?
A 1031 exchange (named for Section 1031 of the Internal Revenue Code) is a tax-deferral strategy that allows real estate investors to sell an investment property and defer capital gains taxes by reinvesting the proceeds into a 'like-kind' replacement property. It is one of the most powerful wealth-building tools available to real estate investors.
1031 Exchange Rules
45-Day Identification Window
After closing the relinquished (sold) property, the investor has 45 calendar days to identify up to three potential replacement properties in writing. Missing this deadline disqualifies the exchange.
180-Day Closing Deadline
The replacement property must be purchased and closed within 180 days of the relinquished property closing (or the due date of the tax return for the year of the sale, if earlier). Both deadlines run simultaneously.
Qualified Intermediary Required
The investor cannot touch the sale proceeds. A Qualified Intermediary (QI) holds the funds between transactions. Using a QI is mandatory — if the investor receives funds, the exchange is disqualified and full capital gains are recognized immediately.
Like-Kind Property
In real estate, 'like-kind' is broadly defined: any investment or business real property can be exchanged for any other investment real property (SFR to apartment, land to commercial, etc.). Does not apply to primary residences, fix-and-flip inventory, or personal property.
1031 Exchange FAQ
What taxes does a 1031 exchange defer?
A 1031 exchange defers federal capital gains tax (0%, 15%, or 20% depending on income) and depreciation recapture tax (25%). State taxes may also be deferred depending on the state. The taxes are deferred, not eliminated — they are owed when the replacement property is eventually sold without another exchange.
Can I do a 1031 exchange into a Delaware Statutory Trust (DST)?
Yes. DSTs are pre-structured fractional ownership interests in institutional real estate (apartment complexes, retail centers, industrial). They qualify as like-kind real property for 1031 purposes, are completely passive, and have no management requirements. This makes them popular for retiring landlords who want to defer taxes but stop managing property.
What happens if I receive 'boot' in a 1031 exchange?
'Boot' is any proceeds the investor receives that are not reinvested in the replacement property — cash, net debt relief, or non-like-kind property. Boot is taxable in the year of the exchange. To fully defer taxes, investors must acquire replacement property of equal or greater value and reinvest all net equity.
Can a primary residence qualify for a 1031 exchange?
No. A 1031 exchange applies only to investment and business use property, not personal residences. However, homeowners can exclude up to $250,000 ($500,000 for married couples) of capital gain under IRC Section 121, the primary residence exclusion. Some investors use a strategy of converting investment property to a primary residence, but strict rules apply.
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