1031 Exchange

Quick Definition

A 1031 exchange (named for Section 1031 of the IRS tax code) lets a real estate investor sell an investment property and defer capital gains taxes by reinvesting the proceeds into a "like-kind" replacement property within strict time limits. The tax basis carries over to the new property, and the tax is deferred indefinitely, potentially until death when heirs receive a stepped-up basis that can eliminate the deferred tax entirely.

What It Means

Selling an investment property for a profit triggers capital gains taxes of 15 to 20% federal, plus state taxes, plus depreciation recapture at 25%. On a $500,000 gain, that can mean $100,000 to $150,000 owed to the government. A 1031 exchange lets you defer that entire tax bill by rolling the proceeds into a new property, keeping 100% of your equity working for you instead of sending a chunk to the IRS.

Done repeatedly over a lifetime, 1031 exchanges allow real estate investors to build wealth by "trading up" into larger or better properties without ever paying capital gains tax. The deferred tax can potentially be eliminated at death through the stepped-up basis, which resets the property's cost basis to fair market value for heirs.

The One Big Beautiful Bill Act (OBBBA), signed into law in July 2025, confirmed that Section 1031 remains fully intact. Multiple federal budget proposals between 2022 and 2025 attempted to cap or eliminate 1031 exchanges, including a $500,000 cap and a proposal to eliminate exchanges for high-income taxpayers. All of those proposals were rejected. Section 1031 enters 2026 with no new restrictions, no caps, and no income limits. You can read the full IRS guidance on like-kind exchanges at IRS.gov.

How It Works

The Core Requirements

The Timeline: 45 Days and 180 Days

Both clocks start on the same day you close the sale of your relinquished property. They run in parallel, not in sequence.

The 45-day rule is absolute. No extensions are available except for federally declared disasters. Missing it by one day disqualifies the entire exchange.

One hidden trap: the 180-day closing deadline is capped at your tax return due date (with extensions) for the year of sale. If you sell a property in November or December, your 180-day clock might get cut short by the April 15 filing deadline. File Form 4868 to extend your tax return and restore the full 180 days.

Property Identification Rules

Most investors use the 3-property rule because it is simpler and sufficient for most situations.

Reporting the Exchange

File Form 8824 (Like-Kind Exchanges) with your federal tax return for the year the relinquished property was transferred. This form reports the dates of sale, identification, and acquisition, allowing the IRS to verify compliance with the 45-day and 180-day deadlines. You must file Form 8824 even if no gain is recognized.

Real-World Examples

Deferred Tax Calculation

Property sold:

• Purchase price (2010): $300,000
• Improvements: $50,000
• Depreciation taken (14 years): $127,273
• Adjusted basis: $300,000 + $50,000 - $127,273 = $222,727
• Sale price: $700,000
• Realized gain: $700,000 - $222,727 = $477,273

Tax deferred with 1031 exchange:

By exchanging into a $700,000 replacement property, the investor keeps $143,818 working rather than paying it to the government. That money continues to compound through real estate depreciation, appreciation, and rental income.

Boot: The Tax Trigger

"Boot" is anything of value received in the exchange that is not like-kind property. It is taxable.

Example: Sold at $700,000 with $200,000 mortgage, received $500,000 proceeds. Bought replacement at $650,000 with $150,000 mortgage. Boot = $500,000 received minus $450,000 reinvested = $50,000 cash boot plus $50,000 net mortgage reduction = $100,000 taxable boot.

The Stepped-Up Basis: The Ultimate Exit

When property held through 1031 exchanges passes to heirs at death, heirs receive a stepped-up cost basis to fair market value at the date of death. All deferred capital gains from lifetime 1031 exchanges are permanently eliminated. Heirs can immediately sell without paying the inherited gain.

This is the "swap till you drop" strategy: exchange properties repeatedly throughout life, deferring all gains, and pass the appreciated portfolio to heirs who receive a clean basis.

Example: $300,000 property exchanged into $700,000 property, then passes to heirs when worth $900,000. Heirs' basis = $900,000. They sell for $900,000 and owe $0 in capital gains tax.

Special Exchange Types

The DST market has grown wider in 2026, spanning multifamily, industrial, self-storage, healthcare, net-lease, and mineral royalties. A DST closes in days with no financing contingency, which makes it useful as both a backup identification and a tool to absorb leftover boot. This matters more in 2026 because deals are taking longer to close and financing is less predictable than it was a few years ago.

What Changed in 2025 and 2026

The OBBBA, signed in July 2025, preserved Section 1031 and added several benefits that interact with 1031 exchange strategy:

1. 100% bonus depreciation made permanent. When you acquire a replacement property through a 1031 exchange and commission a cost segregation study, components reclassified from the 27.5-year building category to shorter-lived property (typically 5, 7, or 15 years) are now fully deductible in year one. This applies to qualified property acquired after January 19, 2025.

2. Estate tax exemption expanded. The higher exemption amount means more appreciated real estate can pass to heirs free of federal estate tax, making the "swap till you drop" strategy even more powerful.

3. SALT deduction cap increased. The overall limit on state and local tax deductions increased to $40,000 (from $10,000), which benefits investors holding property in high-tax states.

The core mechanics of a 1031 exchange are unchanged. You still have 45 days to identify and 180 days to close. You must use a qualified intermediary. The replacement property must be of equal or greater value, and you must reinvest all net equity for full deferral.

Common Mistakes to Avoid

• Touching the proceeds. If you receive the sale proceeds directly, even briefly, the exchange is disqualified and you owe the full capital gains tax. The QI must hold the funds from the moment of sale.
• Missing the 45-day deadline. No extensions exist except for federally declared disasters. One day late and the entire exchange fails.
• Forgetting to file a tax extension. If you sell late in the year, your 180-day closing window may be cut short by the April 15 filing deadline. File Form 4868 to preserve the full 180 days.
• Not reinvesting all proceeds. Any cash left over (boot) is taxable. If you take $50,000 off the table, that $50,000 is taxed as a capital gain.
• Using a disqualified intermediary. Your attorney, accountant, or real estate agent cannot serve as QI if they have provided other services to you in the past two years. The QI must be independent.
• Buying foreign property. Only U.S. real property qualifies for like-kind treatment. A property in Mexico or Canada does not work.
• Waiting too long to identify. In the 2026 market, deals are taking longer to close. A replacement purchase that once closed in 45 days can now drift toward 60 or 75. Start identifying properties before you even list your relinquished property.

Key Points to Remember

• 1031 exchange defers capital gains tax; it does not eliminate it (except via stepped-up basis at death)
• Strict timelines: 45 days to identify replacement, 180 days to close
• Must use a qualified intermediary; you cannot hold the exchange funds yourself
• Must reinvest all proceeds and replace all debt to defer 100% of gains
• "Boot" (cash or debt reduction received) is immediately taxable
• The OBBBA confirmed in July 2025 that Section 1031 remains fully intact with no caps or restrictions
• 100% bonus depreciation is now permanent, which pairs powerfully with cost segregation studies on replacement properties
• "Swap till you drop" combined with stepped-up basis can permanently eliminate deferred tax at death

Related Concepts

• Capital Gains Tax: The tax you defer with a 1031 exchange
• Depreciation: Reduces your basis over time, creating depreciation recapture tax at sale
• Cap Rate: Used to value the replacement property you acquire
• NOI: Net operating income drives the value of investment real estate
• Real Estate Depreciation: How the IRS lets you deduct wear and tear on rental property
• REIT: An alternative way to invest in real estate without the headaches of direct ownership

For a deeper dive, read our 1031 exchange explained blog post or use our investment return calculator to model how deferred taxes compound over time.

Frequently Asked Questions

Q: Can I do a 1031 exchange on my primary residence? A: No. Section 1031 applies only to investment or business-use property. Your primary residence qualifies for the Section 121 exclusion instead ($250,000 or $500,000 in gains excluded for homeowners who lived in the home 2 of the last 5 years). There is no 1031 exchange equivalent for primary residences.

Q: What is a qualified intermediary and do I need one? A: A qualified intermediary (QI) is a third-party professional who holds the exchange proceeds between the sale and purchase. Using a QI is required, not optional. If you receive the sale proceeds directly (even briefly), the exchange is disqualified and you owe the full capital gains tax. The QI must be independent. Your attorney, accountant, or agent cannot serve as QI if they have provided other services to you in the past two years.

Q: Can I exchange into multiple replacement properties? A: Yes. You can identify up to 3 replacement properties and close on all of them. If you sell one $700,000 property, you could buy two $350,000 replacement properties and still complete a valid exchange as long as you close on identified properties within 180 days and reinvest all proceeds. This is a common strategy for diversifying into multiple smaller properties.

Q: Did the One Big Beautiful Bill change 1031 exchanges? A: No. The OBBBA, signed in July 2025, preserved Section 1031 completely intact. No caps, no income limits, no restrictions on how many times you can use it. The law also made 100% bonus depreciation permanent and expanded the estate tax exemption, both of which make 1031 exchange strategy more powerful.

Q: What is a DST and when should I consider one? A: A Delaware Statutory Trust (DST) is a fractional ownership interest in institutional-grade real estate. DSTs are useful when you cannot find a suitable replacement property within the 45-day window, or when you want passive ownership without management responsibilities. A DST closes in days with no financing contingency, which makes it a reliable backup identification in the 2026 market where financing is less predictable.