What a 1031 Exchange Is

Section 1031 of the Internal Revenue Code allows a like-kind exchange of investment or business-use real estate without recognizing capital gain at the time of the sale. The deferred gain reduces the cost basis of the replacement property and is recognized when (or if) that property is later sold outside of another exchange.

State tax conformity varies. Some states fully conform; others (California in particular) have additional reporting and clawback rules when the replacement property is outside the state. Section 1031 was narrowed in 2018 by the Tax Cuts and Jobs Act to apply only to real property; personal property exchanges no longer qualify.

The Timing Rules (strict, no extensions)

• -Day 1. The relinquished property closes. Sale proceeds go directly to a Qualified Intermediary (QI). The taxpayer cannot have actual or constructive receipt of the funds at any point, or the exchange fails.
• -Day 45. Identification period ends. The taxpayer must identify up to three replacement properties in writing, or follow the 200% rule (more than three, total value not exceeding 200% of relinquished) or the 95% rule (any number if you acquire 95% of identified value).
• -Day 180. Acquisition period ends. The replacement property must close. Filing the tax return for the year of sale can shorten the 180 days, so most exchangers extend their filing if the deadline falls before April 15.
• -Both clocks run concurrently. The 45 and 180 day windows both begin at the closing of the relinquished property. There are no IRS extensions outside of certain federally declared disaster relief situations.

Debt Parity Rule

To fully defer gain, the replacement property must carry debt equal to or greater than the debt paid off on the relinquished property. Any shortfall is treated as "boot" and is taxable as capital gain.

Two ways to avoid boot: bring additional cash to the replacement closing to match the equity, or finance the replacement at a higher LTV so the new debt equals or exceeds the old. Either path requires planning the financing before you ever list the relinquished property.

Common Financing Pitfalls

• -Lender misses the 180 day clock. A retail bank that quotes a 60 to 90 day loan timeline will burn the exchange. Brokers and investor-focused lenders typically close in 21 to 35 days.
• -Lender does not understand debt parity. Quoting an LTV that creates boot defeats the purpose of the exchange. The loan officer needs to model the deal with debt parity in mind.
• -Asset seasoning requirements. Some lenders require funds to season in the borrower's account before closing. The exchange proceeds sit with the QI, not the borrower, which can create artificial documentation issues.
• -Title vesting changes. The same taxpayer who sold the relinquished property must acquire the replacement property. Mid-exchange entity changes (LLC to individual, individual to revocable trust) can break the exchange if not structured correctly with the QI.

Solution: work with a broker and a Qualified Intermediary who have closed 1031 deals before. We coordinate the loan calendar to the exchange calendar from the day the relinquished property goes under contract.

Reverse 1031 Exchange

In a reverse exchange, the replacement property is acquired first and the relinquished property is sold within 180 days. The taxpayer cannot own both properties simultaneously, so an Exchange Accommodation Titleholder (EAT) parks one of the properties on the taxpayer's behalf until the relinquished property closes.

Reverse exchanges are more complex, more expensive (typically $5,000 to $15,000 vs $1,000 to $3,000 for a forward exchange), and lender-restrictive. The financing usually has to be at the EAT entity level, then later assigned to the taxpayer, which not every lender will accommodate. The upside is being able to lock in the right replacement before listing the property you plan to relinquish.

Improvement 1031 Exchange

An improvement exchange (sometimes called a build-to-suit exchange) lets the taxpayer use exchange proceeds to make improvements to the replacement property. The improvements must be completed and the property valued at the improved amount before the 180-day window closes for the improved value to count toward the exchange.

This works well when the replacement property is a fix-and-hold or a new construction. The financing structure usually involves a construction or renovation loan held by the EAT, converted to a take-out loan once the improvements are complete.

Like-Kind Definition for Real Estate

"Like-kind" is interpreted broadly for real estate. Almost any investment or business real property is like-kind to any other investment or business real property, regardless of the specific property type.

• Residential rental to commercial office: like-kind.
• Single-family rental to multifamily: like-kind.
• Vacant land to apartment building: like-kind.
• Industrial warehouse to mixed-use building: like-kind.
• Direct real estate to fractional interest in a DST: like-kind.

A primary residence is not like-kind to investment property. That falls under Section 121 with separate rules.

Repeated 1031 Exchanges and Step-Up at Death

There is no limit on how many times you can chain 1031 exchanges. The classic high-net-worth strategy is "swap till you drop": keep rolling gains forward through successive exchanges, hold until death, and pass the portfolio to heirs.

At death, heirs generally receive a stepped-up basis to fair market value, which eliminates the deferred gain entirely. The taxpayer used the property for decades without ever paying capital gains tax on appreciation, and the heirs inherit at the current value.

Delaware Statutory Trust (DST) as Replacement

A Delaware Statutory Trust holds institutional-grade real estate (apartment communities, industrial portfolios, medical office, etc.). Investors buy fractional beneficial interests, and those interests qualify as like-kind real estate for 1031 purposes.

• Passive investment, no active management.
• Depreciation passes through to investors.
• Typical minimum is $100,000.
• Sponsor fees and ongoing fees apply.
• Illiquid until the sponsor sells the underlying property.

DSTs are useful when an investor wants to defer gains but is done dealing with tenants and toilets. They are securities and are sold only through broker-dealers registered with the SEC. This site does not sell DSTs; we point investors to firms that do.

Cost of a 1031

• Qualified Intermediary fees: typically $1,000 to $3,000 per forward exchange.
• Reverse exchange: $5,000 to $15,000 including EAT setup.
• DST sponsor fees: vary by offering, disclosed in the PPM.
• Standard transaction costs: title, escrow, lender, appraisal.
• Legal review of the exchange agreement for high-dollar deals.

When NOT to Do a 1031

• -Modest gain. If the capital gain is small, the QI and transaction costs eat the tax benefit. Run the math first.
• -You want to cash out. An exchange forces the proceeds into another property. Taking cash out defeats the purpose and creates boot.
• -Already past the windows. If 45 or 180 days have passed without identification or close, the exchange is done. There is no retroactive cure.
• -You can offset with losses or low brackets. In years where you have capital losses or are in a lower bracket, paying the tax outright can be cheaper than the complexity.