What is a 1031 exchange?

A 1031 exchange, named for the tax code section, allows an owner to sell investment or business real property and defer the capital gains tax by reinvesting the proceeds into like-kind replacement property. Like-kind is interpreted broadly for real estate, so an apartment building can be exchanged for raw land or a commercial property. The tax is deferred rather than forgiven, carrying forward in a reduced basis on the new property, and investors can chain exchanges indefinitely. If the property is held until death, heirs may receive a stepped-up basis, which is why this is a significant estate planning tool as well as a transactional one.

The deadlines are unforgiving and are where exchanges fail. From the closing of the sale, you have 45 days to formally identify potential replacement properties in writing, subject to identification rules limiting how many and what total value you may name, and 180 days from that same closing to complete the purchase. There are no extensions for ordinary difficulties. Critically, you cannot take possession of the sale proceeds at any point; the funds must be held by a qualified intermediary, and constructive receipt of the money disqualifies the entire exchange.

Two important limits. The Tax Cuts and Jobs Act restricted 1031 treatment to real property, so exchanges of equipment, vehicles, artwork, and other personal property no longer qualify. And it does not apply to a primary residence, which has its own separate exclusion of gain for owners who lived there two of the past five years. If you receive cash or reduce your mortgage debt in the exchange, that difference is boot and is taxable to the extent of gain. Given the deadlines, the intermediary requirement, and the interaction with depreciation recapture, this is a transaction to plan with a tax advisor and a qualified intermediary before listing the property, not after accepting an offer.