1031 Like-Kind Exchange

A 1031 exchange (named after Internal Revenue Code Section 1031) is a tax-deferral strategy that allows investors to sell one investment property and reinvest the proceeds into another like-kind property without recognizing capital gains at the time of sale.

The tax is deferred — not eliminated — and carries forward until you eventually sell the replacement property without doing another exchange. However, holding until death triggers a step-up in basis that can eliminate the deferred gain entirely.

• Applies to real property held for investment or business use only — not personal residences or property held primarily for sale (dealer property).
• Effective January 1, 2018, personal property (equipment, vehicles, artwork) no longer qualifies for 1031 exchanges.

Tip: Real estate investors who exchange repeatedly over decades and hold until death can pass highly appreciated portfolios to heirs entirely free of capital gains tax.

For a valid 1031 exchange, both the relinquished and replacement properties must qualify under several key rules.

Rule	Requirement
Property type	Real property held for investment or business (not personal use)
Like-kind	Broad — any U.S. real estate for any other U.S. real estate
Titling	Replacement property must be titled in the same name as relinquished property
Equal or greater value	To defer all gain, replacement must cost ≥ net sale price
Equal or greater equity	New mortgage + equity ≥ old mortgage + equity to avoid boot
Qualified Intermediary	Required — you cannot touch the proceeds between transactions

A Qualified Intermediary (QI) is a third-party escrow agent that holds proceeds from the sale and disburses them directly to the replacement property seller. Using an attorney, accountant, or agent who has worked with you recently generally disqualifies them as a QI.

Section 1031 imposes two strict deadlines that cannot be extended (with rare disaster exceptions). Missing either deadline disqualifies the exchange and makes the entire gain taxable.

• 45-Day Identification Period: You must identify in writing to your QI the addresses or legal descriptions of up to three potential replacement properties (or more under the 200% or 95% rules) within 45 calendar days of closing the sale.
• 180-Day Exchange Period: You must close on one of the identified replacement properties within 180 calendar days of the original sale (or the tax return due date including extensions, whichever is earlier).

Warning: The 45 and 180-day clocks start on the closing date of the relinquished property — not when you sign a contract or receive funds. If you sell in late September, the 180-day period may end before April 15, making it wise to file for an extension so the full 180 days apply.

The standard 1031 exchange requires selling first and buying second. Two advanced variations accommodate situations where the order is reversed or the replacement needs upgrading.

Reverse Exchange: You acquire the replacement property before selling the relinquished one. An Exchange Accommodation Titleholder (EAT) takes title to one of the properties while you complete the exchange. The same 45/180-day deadlines apply from the date the EAT acquires the parked property. Reverse exchanges require more capital because you must close on the replacement property before receiving sale proceeds.

Improvement Exchange (Build-to-Suit): Allows you to use exchange proceeds to make improvements on the replacement property before receiving title. The EAT holds the replacement property during construction, and all improvements must be completed within the 180-day window.

Exchange Type	Buy First?	Complexity	Typical Extra Cost
Standard (forward)	No	Low	$1,000–$3,000 QI fees
Reverse	Yes	High	$5,000–$15,000+
Improvement (build-to-suit)	Yes	High	$5,000–$15,000+

Boot is any non-like-kind value received in a 1031 exchange. It triggers immediate taxation on the gain recognized, up to the amount of boot received.

• Cash boot: Proceeds not reinvested into the replacement property.
• Mortgage boot: If the replacement property has less debt than the relinquished property, the difference is treated as boot even if no cash changes hands.

Example: You sell a property for $800,000 with a $200,000 mortgage (equity $600,000) and buy a replacement for $750,000 with a $150,000 mortgage. The $50,000 debt reduction is mortgage boot — taxable even though you received no cash.

The basis in the replacement property equals the basis in the relinquished property plus any boot paid minus any boot received. This carryover basis preserves the deferred gain for future taxation.

Item	Effect
Cash received at closing	Taxable as boot (capital gain)
Net debt decrease	Taxable as mortgage boot
Depreciation recapture	Taxed at up to 25% on deferred portion when eventually sold
Basis in new property	Carryover basis (lower than market value)