1031 Exchange
Definition
A tax-deferral strategy that allows real estate investors to sell a property and reinvest the proceeds in a like-kind property without paying capital gains tax at the time of sale.
A 1031 exchange (named after Section 1031 of the Internal Revenue Code) lets you defer capital gains tax when you sell an investment property by reinvesting the proceeds into another investment property. The key word is "defer" — the tax isn't eliminated, it's postponed until you eventually sell without exchanging.
The rules are strict: you must identify replacement properties within 45 days of selling and close on the new property within 180 days. A qualified intermediary must hold the sale proceeds — you can never take possession of the funds. The replacement property must be "like-kind" (broadly defined for real estate — an apartment building can be exchanged for raw land).
The tax savings are substantial. If you sell a property with $200,000 in gains and $100,000 in depreciation recapture, you could owe $40,000-$70,000+ in taxes. A 1031 exchange defers this entire amount, keeping that capital working in your next investment. Serial 1031 exchanges can defer taxes indefinitely.
Investors can use the "swap 'til you drop" strategy: continuously exchanging into larger or higher-quality properties throughout their career. At death, heirs receive a stepped-up basis, potentially eliminating all the deferred capital gains tax permanently. This combination of 1031 exchanges and stepped-up basis is one of the most powerful wealth-building strategies in real estate.
Limitations include: you cannot exchange into a primary residence (must be investment or business property), personal property no longer qualifies after the 2017 tax reform, and the timelines are firm with very few exceptions. Delaware Statutory Trusts (DSTs) provide a passive 1031 exchange option for investors who don't want to manage another property.
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Frequently Asked Questions
Can I 1031 exchange into a property I'll live in?
Not directly — the replacement property must be held for investment or business use. However, you can exchange into an investment property, hold it for 1-2+ years as a rental, and then convert it to your primary residence. The IRS scrutinizes conversions shortly after exchange, so holding as investment for a meaningful period is important.
What are the deadlines for a 1031 exchange?
45 days from the sale to identify replacement properties (up to 3 properties, or any number if total value doesn't exceed 200% of the sold property). 180 days from the sale to close on the replacement property. These deadlines are strict — calendar days, not business days, with almost no extensions.