1031 like-kind exchange

The 1031 exchange (named after IRC Section 1031) is a deferral mechanism allowing real estate investors to sell a property and buy a similar replacement property while deferring all capital gains and depreciation recapture taxes indefinitely. The exchange must follow strict timing requirements (45 days to identify, 180 days to close on the replacement property). This is one of the most powerful tax tools for real estate investors.

How a 1031 exchange works

You own a rental apartment building bought for $500,000. It is now worth $1 million. Your capital gain is $500,000; you have taken $200,000 in depreciation recapture. Tax owed (at 25% recapture rate): ~$125,000.

Instead of selling and paying tax, you do a 1031 exchange: sell the apartment building for $1 million, then buy a replacement property (warehouse, office building, retail space—any real estate) for $1 million (or more).

Result: Zero tax is owed. The $500,000 gain and $200,000 recapture are deferred indefinitely. You now own the replacement property with a carryover basis that preserves the deferred tax.

The 45-day identification rule

Within 45 days of selling the relinquished property, you must identify the replacement property in writing. This does not mean you must close on it; you simply must notify your exchange intermediary or the IRS of the property you intend to buy.

You can identify up to three properties, or more if you have more inventory and exceed certain value thresholds.

The 45-day deadline is strict. Missing it by one day disqualifies the exchange.

The 180-day closing rule

You have 180 days from the sale of the relinquished property to close on the replacement property. This includes the 45-day identification period.

Example: Sell on January 1. By March 16 (45 days), identify the replacement. By June 29 (180 days), close on the replacement.

The 180-day deadline is also strict. Extensions are not permitted for market conditions or financing delays.

Like-kind requirement

The replacement property must be “like-kind” to the relinquished property. After the Tax Cuts and Jobs Act (2017), “like-kind” is broadly interpreted for real estate:

• Apartment building for office building ✓
• Apartment building for raw land ✓
• Apartment building for commercial property ✓

Essentially, any real estate qualifies as like-kind with any other real estate. (Real property and personal property do not exchange; and foreign property cannot exchange with US property.)

Boot and its tax

If you receive cash or other non-real-estate consideration (called “boot”), that amount is taxable. You cannot fully defer if the replacement property is cheaper than the relinquished property.

Example: Sell for $1 million. Buy a replacement for $800,000. You receive $200,000 “boot” (cash). That $200,000 is taxable (up to your capital gain).

To fully defer, you must “trade up” or exchange for equal or greater value.

The intermediary

You cannot directly exchange properties. A qualified intermediary must hold the proceeds from the sale and use them to purchase the replacement. The intermediary is a neutral third party; common ones include FirstTitl 1031, Investors Trust, and many title companies.

Intermediary fees are typically $500-$1,500.

Depreciation recapture and 1031

The depreciation recapture is also deferred in a 1031 exchange. This is massive: you preserve the deferred recapture and can keep taking depreciation deductions on the replacement property.

Example: Building A: basis $300,000, $200,000 in depreciation recapture. Exchange for Building B: carryover basis $300,000. You resume taking depreciation on Building B without paying recapture tax.

Reverse exchanges and build-to-suit

Modern rules allow “reverse exchanges” where you identify and close on the replacement property before selling the relinquished property. Rules are complex; consult an intermediary.

“Build-to-suit” exchanges allow you to build a replacement property using the deferred funds, within the 180-day window.

Reporting: Form 8824

You report 1031 exchanges on Form 8824 (Like-Kind Exchanges). This form details the relinquished property, the replacement, dates, and the deferred capital gain. The form is complex; your tax professional should prepare it.

The deferral is not eliminated

The 1031 exchange defers tax indefinitely, but does not eliminate it. When you eventually sell the replacement property without doing another 1031 exchange, the deferred tax becomes due.

Savvy investors use a succession of 1031 exchanges to defer indefinitely. On death, the step-up in basis erases the deferred tax.

Limitations and changes

The Tax Cuts and Jobs Act eliminated 1031 exchanges for personal property (effective 2018). Real estate exchanges remain available.

Future legislative changes could limit or eliminate 1031 exchanges. Do not rely on indefinite deferral without considering this risk.

See also