1031 Exchange Rules Guide

You are selling a rental property you bought for $180,000 a decade ago. It is now worth $360,000. After depreciation recapture, you have approximately $150,000 in capital gains. At the 15% long-term capital gains rate (assuming your income puts you in this bracket), that is a $22,500 tax bill — due the April after you sell. A Section 1031 like-kind exchange lets you defer that entire amount by rolling the proceeds into a replacement property. Here are the rules that make or break the transaction.

What a 1031 Exchange Actually Does

The IRS treats the exchange as if you never received the sale proceeds — they pass through a qualified intermediary (QI) directly to the purchase of the replacement property. Because you never constructively received the money, no gain is recognized in that tax year. The deferred gain carries forward as a lower cost basis on the replacement property.

On the $150,000 gain example: you defer $22,500 at 15% (plus 3.8% NIIT if your income exceeds $200,000 single or $250,000 married — that's an additional $5,700 deferred). You reinvest the full proceeds and compound the government's money alongside your own.

The Two Deadlines That Cannot Be Extended

45-day identification rule. From the day you close on the sale (the "relinquished property"), you have 45 calendar days to identify in writing to your QI the replacement properties you intend to buy. No exceptions. Miss this deadline and the entire exchange collapses — you owe the deferred tax immediately.

You have three identification rules to choose from:

• 3-property rule: Identify up to 3 properties of any value
• 200% rule: Identify any number of properties whose combined fair market value does not exceed 200% of the relinquished property's value
• 95% rule: Identify any number of properties if you ultimately acquire at least 95% of their total value (rarely used — very hard to execute)

Most exchangers use the 3-property rule. Identify three candidates, then secure the one that closes in time.

180-day closing rule. You must close on the replacement property within 180 calendar days of the sale of the relinquished property — or the due date of your tax return (including extensions) for the year of the sale, whichever is earlier.

Sell on June 1 and your 180-day deadline is November 28. But your tax return for that year is due April 15 (or October 15 with extension). In this case, the April 15 deadline is earlier — you must either file for an extension (pushing the deadline to October 15) or close before April 15. Always verify which deadline is earlier.

Like-Kind: What Qualifies

"Like-kind" is broader than most people expect for real estate. Any U.S. real property held for investment or productive use in trade or business can be exchanged for any other U.S. real property held for investment or productive use.

Qualifying exchanges include:

• Single-family rental traded for a duplex
• Raw land traded for an apartment building
• Commercial building traded for a portfolio of residential rentals
• One rental property traded for a vacation rental (if held for rent, not personal use)

What does not qualify:

• Primary residence (not investment property)
• Property held primarily for sale (fix-and-flip inventory — dealers cannot use 1031)
• Real property in the U.S. exchanged for foreign real property
• Personal property (artwork, equipment) — 1031 was limited to real estate after the 2017 Tax Cuts and Jobs Act

Boot: When You Owe Tax Anyway

Boot is any non-like-kind value received during the exchange. If your sale proceeds exceed what you reinvest, the difference is boot — and it is taxable.

Cash boot: You sell for $360,000, clear $320,000 after paying off your mortgage, and only purchase a $280,000 replacement property. The $40,000 you receive in excess is cash boot — taxable up to the amount of deferred gain.

Mortgage boot (debt relief): You sell a property with a $150,000 mortgage and buy a replacement with only a $100,000 mortgage. The $50,000 reduction in debt is treated as if you received $50,000 in cash — also boot, also taxable.

To avoid boot entirely: buy equal or greater in value, and take on equal or greater debt on the replacement property.

The Reverse Exchange

Standard 1031: sell first, then buy within 180 days. In a competitive market where you need to close on the replacement property before your current property sells, a reverse exchange lets you acquire the replacement property first.

The QI or an Exchange Accommodation Titleholder (EAT) holds title to the new property while you sell the relinquished property — within 180 days. Reverse exchanges cost more (the EAT charges holding fees) and are more complex, but they protect your timeline when you cannot wait to identify a replacement after selling.

Cost Basis After the Exchange

The deferred gain does not disappear — it converts into a lower cost basis on the replacement property. If your basis in the old property was $180,000 and the deferred gain is $150,000, your basis in the new property (excluding any adjustments) starts at $210,000 — the replacement purchase price minus the deferred gain.

When you eventually sell the replacement property without another 1031 exchange, you will owe capital gains on the entire accumulated deferred gain plus any new appreciation. Estate planning note: properties held until death get a stepped-up basis, potentially eliminating the deferred gain entirely for heirs.

This article provides general real estate information for educational purposes. Consult a licensed real estate professional or tax advisor for advice specific to your transaction and situation.