The 1031 Exchange (IRC §1031): Deferring Gain on Like-Kind Real Estate
In Short
A 1031 Exchange is a swap of real property held for business or investment for other like-kind real property, which under IRC §1031 defers the gain instead of taxing it at the time of the sale. It is commonly used by real estate investors and business owners who sell one property and buy another.
TL;DR
- Since 2018, only real property qualifies; equipment, vehicles and other personal property do not [1][3].
- Replacement property has to be identified within 45 days and received within 180 days or by the return due date, if earlier [1].
- A qualified intermediary commonly holds the sale proceeds so the seller does not receive them [2].
- Cash or other non-like-kind property received, called boot, is taxed to the extent of the gain [1].
- Exchanges are reported on Form 8824, and exchanges with related persons have a two-year holding rule [1][4].
Quick Facts
| Legal Reference | IRC §1031 |
|---|---|
| Complexity | High |
| Audit Risk | Medium |
| Setup Cost | Moderate — qualified intermediary fees plus closing costs |
| Time to Implement | Up to 180 days per exchange, with planning before the sale |
| Illustrative Example | Illustrative example, not a projection. An investor sells a rental building for $1,000,000 with an adjusted basis of $400,000, so the gain is $600,000. Using a qualified intermediary, the investor identifies replacement property within 45 days and buys a $1,100,000 building within 180 days. Because no cash is received and the replacement costs more, the gain is deferred, and the new building's basis reflects the deferred gain. If the investor had taken $100,000 of cash out, about $100,000 of the gain would be taxed now. Actual results depend on the facts. |
Key Numbers & Limits
| Item | Limit or Rule | Notes |
|---|---|---|
| Eligible Property | Real property held for productive use in a business or for investment | Personal property no longer qualifies after 2017 [1][3]. |
| Identification Period | 45 days after transferring the relinquished property | [1] |
| Exchange Period | 180 days, or the due date (with extensions) of the return for that year, if earlier | [1] |
| Identification Rules | Up to 3 properties, or any number up to 200% of the relinquished property's value | Treas. Reg. §1.1031(k)-1(c)(4) [2]. |
| Related-Person Holding Period | 2 years after the last transfer | [1] |
What Is a 1031 Exchange?
A 1031 exchange is a transaction in which no gain or loss is recognized when real property held for productive use in a trade or business or for investment is exchanged solely for real property of a like kind [1]. The name comes from section 1031 of the Internal Revenue Code. The gain is not forgiven; it is deferred and carried into the replacement property through its basis.
Since the Tax Cuts and Jobs Act, section 1031 applies only to exchanges of real property. Exchanges of personal or intangible property — such as equipment, vehicles, artwork or patents — no longer qualify [3]. Most real property is like-kind to other real property, whether it is improved or not, but real property in the United States is not like-kind to real property outside the United States [1][3].
Property held mainly for sale, such as lots built and sold by a developer, does not qualify, and neither does a personal residence [1][3]. Most modern exchanges are deferred exchanges: the seller sells the old property first and buys the new property later, within strict time limits.
How Does a 1031 Exchange Work?
- Before closing on the sale, the owner signs an exchange agreement with a qualified intermediary, a person who is not the owner's agent and who holds the sale proceeds [2].
- The relinquished property is sold, and the proceeds go to the intermediary; the owner's rights to receive, pledge or borrow those funds are limited in writing [2].
- Within 45 days, the owner identifies replacement property in writing, using either the three-property rule or the 200% rule [1][2].
- Within 180 days, or by the return due date if earlier, the intermediary acquires the replacement property and transfers it to the owner [1][2].
- Any cash or non-like-kind property the owner receives, including some debt relief, is boot and is taxed up to the amount of the gain [1].
- The owner reports the exchange on Form 8824 for the year the relinquished property was transferred [4].
The Good: What Are the Benefits of a 1031 Exchange?
- Gain on the sale of business or investment real estate can be deferred, so the full equity stays invested [1].
- There is no limit on how many times an owner can exchange or on the dollar amount deferred [1].
- Owners can move between kinds of real estate, such as from land to an apartment building, since most real property is like-kind [3].
- Deferred gain carried until death may never be taxed as income if the heirs' basis is stepped up under IRC §1014 [5].
The Bad: What Are the Drawbacks of a 1031 Exchange?
- The 45-day and 180-day deadlines are strict, and the statute does not extend them for a slow market [1].
- Receiving cash or reducing debt without replacing it creates taxable boot [1].
- Personal property, such as furniture or equipment sold with a building, does not qualify and may be taxed [3].
- The replacement property takes a lower basis, which means smaller future depreciation deductions.
- Intermediary fees and the pressure to find a property quickly add cost.
The Ugly: What Are the Serious Risks of a 1031 Exchange?
- Touching the sale proceeds — even briefly — can mean the owner is in actual or constructive receipt of the money, which can make the whole gain taxable [2].
- If an exchange is with a related person and either party disposes of the property within two years, the deferred gain is generally recognized [1].
- A qualified intermediary that fails or misuses funds can leave the owner with a failed exchange and lost money, so owners commonly check how the intermediary holds and protects funds.
- Failed or improperly reported exchanges can bring tax, interest and a 20% accuracy-related penalty on the underpayment [6].
Who Uses a 1031 Exchange?
Who It's Commonly Used By
Who It's Generally Not Suited For
What Are the Key Rules & Requirements for a 1031 Exchange?
- Only real property held for productive use in a trade or business or for investment qualifies [1].
- Real property held primarily for sale does not qualify [1].
- U.S. real property is not like-kind to foreign real property [1][3].
- Replacement property must be identified within 45 days and received within 180 days or by the return due date, whichever is earlier [1].
- Boot is taxed to the extent of the gain; losses on an exchange are not recognized [1].
- Exchanges with related persons are taxed if either party disposes of the property within two years, with some exceptions [1].
- A qualified intermediary may not be the owner or a disqualified person, such as the owner's agent within the prior two years [2].
What Are Common Mistakes & Red Flags With a 1031 Exchange?
- Proceeds deposited into the owner's own account before the replacement is bought [2].
- Using the owner's regular attorney, accountant or broker as the intermediary, who may be a disqualified person [2].
- Identifying replacement property informally or after day 45 [1].
- Buying a vacation home and using it mostly for personal stays.
- Exchanging with a family member or controlled entity without tracking the two-year rule [1].
- Assuming equipment or furnishings sold with a building are covered [3].
Frequently Asked Questions
What Property Qualifies for a 1031 Exchange?
Since 2018, only real property held for productive use in a trade or business or for investment qualifies. Personal property, intangible property, a personal residence and property held mainly for sale do not [1][3].
What Are the 45-Day and 180-Day Rules?
Replacement property must be identified within 45 days after the old property is transferred, and it must be received by the earlier of 180 days or the due date, with extensions, of the tax return for that year [1].
What Is Boot in a 1031 Exchange?
Boot is cash or other property that is not like-kind real property. When boot is received, gain is recognized up to the value of the boot [1].
Do I Need a Qualified Intermediary for a 1031 Exchange?
Most deferred exchanges use one. The regulations provide a safe harbor in which a qualified intermediary holds the proceeds so the seller is not treated as receiving them [2]. The intermediary cannot be the seller or a disqualified person [2].
How Is a 1031 Exchange Reported?
On Form 8824, Like-Kind Exchanges, filed with the return for the year the relinquished property was transferred [4].
Sources
- 26 U.S. Code §1031 — Exchange of Real Property Held for Productive Use or Investment — Legal Information Institute, Cornell Law School
- 26 CFR §1.1031(k)-1 — Treatment of Deferred Exchanges — Legal Information Institute, Cornell Law School
- Like-Kind Exchanges — Real Estate Tax Tips — Internal Revenue Service
- About Form 8824, Like-Kind Exchanges — Internal Revenue Service
- 26 U.S. Code §1014 — Basis of Property Acquired From a Decedent — Legal Information Institute, Cornell Law School
- 26 U.S. Code §6662 — Imposition of Accuracy-Related Penalty on Underpayments — Legal Information Institute, Cornell Law School
Primary sources only: the Internal Revenue Code, Treasury regulations and official agency guidance. Read how Zentavos researches these reports.