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Setting an Asking PriceUsing a Business BrokerSelling a Business During DivorceSelling a Failing BusinessTransferring Intellectual PropertyPreparing an Online Business for SalePreparing for Sale, Two Years OutSelling a Business QuicklyWriting a Selling MemorandumSelling a Business Step by StepSelling a Business With DebtChanges Worth Making Before SellingA 1031 like-kind exchange lets you defer capital gains tax when selling investment real estate -- potentially indefinitely. This guide explains what the calculator computes, how to read every output, the 45/180-day timeline, boot, depreciation recapture, and how a perpetual exchange strategy compounds wealth tax-deferred.
Section 1031 of the Internal Revenue Code allows an investor to sell one investment property and purchase another of "like-kind" without paying capital gains tax at the time of the sale. The tax is not eliminated -- it is deferred to a future sale where the investor does not perform another exchange.
The economic logic: instead of paying 20-40% of your gain to the government at sale, you reinvest the full pre-tax proceeds into the replacement property. You have more capital working for you, compounding over time. The government's share is essentially an interest-free loan from the IRS -- you hold it and invest it until you eventually pay at a future sale (or your heirs inherit with a stepped-up basis, potentially eliminating it entirely).
Introduced in the Revenue Act of 1921, Section 1031 has been used by real estate investors for over 100 years. The Tax Cuts and Jobs Act of 2017 narrowed its scope to real property only -- eliminating like-kind exchanges of personal property (equipment, aircraft, artwork) that were previously permitted. Today, 1031 exchanges apply only to real estate used in a trade or business or held for investment.
The compounding advantage in numbers
An investor sells a $1M property with $500K of gain. Without a 1031, taxes of approximately $175K (35% combined rate) leave $825K to reinvest. With a 1031, the full $1M reinvests. Over 10 years at 7% annual appreciation, that $175K difference compounds to over $340K in additional wealth -- even before considering leverage on the larger purchase. The calculator quantifies this exact advantage.
Without 1031 exchange
Taxable sale
Pay capital gains + depreciation recapture now. Reinvest the net proceeds after tax. Smaller capital base compounding going forward.
With 1031 exchange
Tax-deferred
Defer all capital gains and recapture tax. Reinvest full pre-tax proceeds. Larger capital base compounding. Repeat indefinitely. Extinguish at death via step-up.
Before modeling an exchange, you need to know exactly how much tax you are deferring. Three separate taxes apply to most real estate sales.
Realized gain
Realized gain = Sale price - Selling costs - Adjusted basis
Adjusted basis = Original purchase price + capital improvements - accumulated depreciation taken. The depreciation component is critical: depreciation deductions taken over the years of ownership reduce the basis and increase the gain dollar-for-dollar at sale.
Adjusted basis calculation
Adj. basis = Purchase price + Improvements - Accumulated depreciation
Example: Bought for $500,000. Added $100,000 of improvements. Claimed $120,000 of depreciation over 10 years. Adjusted basis = $500K + $100K - $120K = $480,000. If sold for $900,000 with $40,000 of selling costs: Realized gain = $900K - $40K - $480K = $380,000.
Tax components on a taxable sale (no 1031)
Depreciation recapture tax = Accumulated depreciation × 25% (max rate)
Long-term capital gains tax = (Gain - Recaptured depreciation) × 20%
Net Investment Income Tax (NIIT) = Total gain × 3.8% (if MAGI > $200K single / $250K MFJ)
Using the example above: Recapture = $120K x 25% = $30,000. LTCG = ($380K - $120K) x 20% = $52,000. NIIT = $380K x 3.8% = $14,440. Total federal tax = $96,440. Plus state tax (0-13.3%). Total tax deferred by a successful 1031 = $96,440 + state.
| Tax type | Rate | What it applies to | Deferred by 1031? |
|---|---|---|---|
| Long-term capital gains | 0% / 15% / 20% | Gain above depreciation recapture, held over 1 year | Yes -- fully deferred |
| Depreciation recapture (Sec. 1250) | Max 25% | Accumulated straight-line depreciation on real property | Yes -- fully deferred |
| Net Investment Income Tax (NIIT) | 3.8% | High-income taxpayers (MAGI over thresholds) on investment income | Yes -- deferred |
| State capital gains tax | 0% -- 13.3% | Most states tax real estate gains (California at full income rate) | Depends on state conformity |
| Short-term capital gains | Ordinary income rate | Property held under 12 months | Not eligible -- cannot use 1031 on short-term holds |
California does not defer on its own
California conforms to the federal 1031 exchange deferral for state income tax purposes -- but only if the replacement property is also in California. If you exchange out of a California property into an out-of-state replacement, California will tax the gain in the year of sale (at rates up to 13.3%) even though you paid no federal tax. This is the most common multi-state 1031 trap. Our calculator has a state conformity flag for this scenario.
The 1031 exchange has two strict, non-negotiable deadlines set by IRS regulations. Missing either one collapses the exchange -- the entire gain becomes taxable immediately. There are no extensions except for federally declared disasters.
Day 0 -- Close of relinquished property
Sale closes -- clock starts
The moment the deed transfers on your relinquished property, both clocks begin. Sale proceeds must go directly to the Qualified Intermediary (QI) -- not to you, your attorney, or your account. Any receipt of funds by you (actually or constructively) triggers taxable boot.
Section 1031 of the Internal Revenue Code allows an investor to sell one investment property and purchase another of "like-kind" without paying capital gains tax at the time of the sale. The tax is not eliminated -- it is deferred to a future sale where the investor does not perform another exchange.
The economic logic: instead of paying 20-40% of your gain to the government at sale, you reinvest the full pre-tax proceeds into the replacement property. You have more capital working for you, compounding over time. The government's share is essentially an interest-free loan from the IRS -- you hold it and invest it until you eventually pay at a future sale (or your heirs inherit with a stepped-up basis, potentially eliminating it entirely).
Introduced in the Revenue Act of 1921, Section 1031 has been used by real estate investors for over 100 years. The Tax Cuts and Jobs Act of 2017 narrowed its scope to real property only -- eliminating like-kind exchanges of personal property (equipment, aircraft, artwork) that were previously permitted. Today, 1031 exchanges apply only to real estate used in a trade or business or held for investment.
The compounding advantage in numbers
An investor sells a $1M property with $500K of gain. Without a 1031, taxes of approximately $175K (35% combined rate) leave $825K to reinvest. With a 1031, the full $1M reinvests. Over 10 years at 7% annual appreciation, that $175K difference compounds to over $340K in additional wealth -- even before considering leverage on the larger purchase. The calculator quantifies this exact advantage.
Without 1031 exchange
Taxable sale
Pay capital gains + depreciation recapture now. Reinvest the net proceeds after tax. Smaller capital base compounding going forward.
With 1031 exchange
Tax-deferred
Defer all capital gains and recapture tax. Reinvest full pre-tax proceeds. Larger capital base compounding. Repeat indefinitely. Extinguish at death via step-up.
Before modeling an exchange, you need to know exactly how much tax you are deferring. Three separate taxes apply to most real estate sales.
Realized gain
Realized gain = Sale price - Selling costs - Adjusted basis
Adjusted basis = Original purchase price + capital improvements - accumulated depreciation taken. The depreciation component is critical: depreciation deductions taken over the years of ownership reduce the basis and increase the gain dollar-for-dollar at sale.
Adjusted basis calculation
Adj. basis = Purchase price + Improvements - Accumulated depreciation
Example: Bought for $500,000. Added $100,000 of improvements. Claimed $120,000 of depreciation over 10 years. Adjusted basis = $500K + $100K - $120K = $480,000. If sold for $900,000 with $40,000 of selling costs: Realized gain = $900K - $40K - $480K = $380,000.
Tax components on a taxable sale (no 1031)
Depreciation recapture tax = Accumulated depreciation × 25% (max rate)
Long-term capital gains tax = (Gain - Recaptured depreciation) × 20%
Net Investment Income Tax (NIIT) = Total gain × 3.8% (if MAGI > $200K single / $250K MFJ)
Using the example above: Recapture = $120K x 25% = $30,000. LTCG = ($380K - $120K) x 20% = $52,000. NIIT = $380K x 3.8% = $14,440. Total federal tax = $96,440. Plus state tax (0-13.3%). Total tax deferred by a successful 1031 = $96,440 + state.
| Tax type | Rate | What it applies to | Deferred by 1031? |
|---|---|---|---|
| Long-term capital gains | 0% / 15% / 20% | Gain above depreciation recapture, held over 1 year | Yes -- fully deferred |
| Depreciation recapture (Sec. 1250) | Max 25% | Accumulated straight-line depreciation on real property | Yes -- fully deferred |
| Net Investment Income Tax (NIIT) | 3.8% | High-income taxpayers (MAGI over thresholds) on investment income | Yes -- deferred |
| State capital gains tax | 0% -- 13.3% | Most states tax real estate gains (California at full income rate) | Depends on state conformity |
| Short-term capital gains | Ordinary income rate | Property held under 12 months | Not eligible -- cannot use 1031 on short-term holds |
California does not defer on its own
California conforms to the federal 1031 exchange deferral for state income tax purposes -- but only if the replacement property is also in California. If you exchange out of a California property into an out-of-state replacement, California will tax the gain in the year of sale (at rates up to 13.3%) even though you paid no federal tax. This is the most common multi-state 1031 trap. Our calculator has a state conformity flag for this scenario.
The 1031 exchange has two strict, non-negotiable deadlines set by IRS regulations. Missing either one collapses the exchange -- the entire gain becomes taxable immediately. There are no extensions except for federally declared disasters.
Day 0 -- Close of relinquished property
Sale closes -- clock starts
The moment the deed transfers on your relinquished property, both clocks begin. Sale proceeds must go directly to the Qualified Intermediary (QI) -- not to you, your attorney, or your account. Any receipt of funds by you (actually or constructively) triggers taxable boot.
Day 45 -- Identification deadline
Written identification of replacement property(ies) due
You must identify potential replacement properties in writing, signed, and delivered to the QI or other permitted party by midnight of Day 45. Three rules govern how many properties you may identify (see Section 09). This deadline cannot be extended. If you miss it or fail to identify valid properties, the exchange fails entirely and all proceeds are taxable.
Days 46-179 -- Exchange period
Close on one or more identified replacement properties
You may close on any of your identified replacement properties during this window. Most investors aim to close by Day 120-150 to provide a buffer for title and financing delays. If you identified multiple properties, you may close on any combination, subject to the identification rules.
Day 180 -- Exchange deadline
All replacement property closings must complete
The earlier of: Day 180 after the close of the relinquished property, or the due date of your federal tax return for the year of sale (including extensions). If you file by April 15 without extension and the exchange straddles two tax years, the April 15 deadline controls -- not Day 180. File an extension to preserve the full 180 days when the exchange straddles December 31.
| Event | Deadline | Consequence of missing | Extension available? |
|---|---|---|---|
| Identification of replacement property | Day 45 | Exchange fails -- full gain taxable | No (disaster exception only) |
| Close on replacement property | Day 180 (or tax return due date) | Exchange fails -- full gain taxable | No (disaster exception only) |
| QI holding period | 180 days max | Proceeds returned as taxable boot | No |
| Tax return filing (exchange year) | April 15 + extensions | Extension preserves full 180 days when straddle occurs | Yes -- file Form 4868 |
File an extension if your exchange straddles December 31
If you close on your relinquished property in October, November, or December, your 180-day period extends into the following year. But your tax return for the year of sale is due April 15 of the next year -- before Day 180 expires. If you do not file a tax return extension (Form 4868), your deadline is April 15, not Day 180. Always file an extension in this situation. The cost is zero; the risk of not filing is losing 2-3 months of exchange time.
Our calculator computes five things: the realized gain on the relinquished property, the tax liability if sold outright (the "tax cost of not exchanging"), the boot and deferred gain in a partial exchange, the minimum replacement property price to defer 100% of gain, and a 10-year wealth comparison between a taxable sale and a successful exchange.
Realized gain (relinquished property)
Gain = Sale price - Selling costs - (Purchase price + Improvements - Accumulated depreciation)
Boot calculation
Boot = max(0, relinquished equity - replacement equity)
Boot = max(0, mortgage relief on relinquished - new mortgage on replacement)
Boot is the smaller of: taxable gain or total boot received. Boot causes the equivalent amount of gain to become taxable -- proportionally split between capital gains and depreciation recapture. The calculator shows both cash boot and mortgage boot (mortgage relief).
Minimum replacement property value (to defer 100%)
Min replacement value = (Sale price - Selling costs) + (Relinquished mortgage - New mortgage)
To fully defer: buy at least as much as your net sale proceeds plus any net mortgage relief. If you pay off a $400K mortgage and take on a $300K mortgage on the replacement, your "mortgage boot" is $100K -- taxable unless you add $100K of equity cash to the replacement purchase.
Adjusted basis in replacement property (carried over)
Replacement basis = Replacement price - Deferred gain + Boot recognized as gain
The deferred gain is embedded in the replacement property's basis. If you paid $1,200,000 for the replacement and deferred $380,000 of gain, your basis in the new property is $820,000 -- not $1,200,000. This deferred gain will become taxable at a future sale (unless you do another exchange or hold until death).
| Calculator section | What it computes |
|---|---|
| Relinquished property panel | Sale price, selling costs, adjusted basis (purchase + improvements - depreciation), realized gain split between recapture and LTCG |
| Tax liability (no exchange) | Federal recapture tax (25%), federal LTCG (20%), NIIT (3.8%), state tax -- total tax cost of not exchanging |
| Exchange requirements | Minimum replacement value to defer 100%, required equity reinvestment, required minimum debt on replacement |
| Replacement property panel | Replacement price, down payment, new mortgage, cash boot, mortgage boot, total boot, taxable gain on boot, gain deferred |
| 10-year wealth comparison | Side-by-side: taxable sale net proceeds compounded at your growth rate vs. exchange proceeds compounded. Shows cumulative advantage in dollars and percentage. |
| Estate planning section | Stepped-up basis at death -- deferred gain eliminated. Illustrates the "perpetual deferral to elimination" strategy. |
| Field | Definition | Where to find it | Common mistake |
|---|---|---|---|
| Relinquished Property | |||
| Sale price | The gross contract price. Do not reduce for selling costs yet -- the calculator handles those separately. | Purchase agreement / closing disclosure | Using net proceeds instead of gross sale price |
| Selling costs | Broker commissions, transfer taxes, legal fees, title, closing costs paid by seller. Typically 5-8% of sale price. | Closing disclosure, broker agreement | Forgetting transfer taxes or pro-rated expenses |
| Original purchase price | What you paid for the property (land + building). Do not include improvements -- those go in the next field. | Original closing disclosure or HUD-1 | Including the original loan amount instead of purchase price |
| Capital improvements | Permanent improvements that extended the property's useful life or added value: new roof, HVAC, addition, renovation. Not maintenance or repairs. | Your depreciation schedule, Form 4562 | Including repairs and maintenance as improvements |
| Accumulated depreciation | Total depreciation claimed on all returns since purchase. Found on your depreciation schedule. Residential: 27.5-yr straight-line. Commercial: 39-yr straight-line. | Prior year Form 4562, tax depreciation schedule | Using book depreciation instead of tax depreciation |
| Existing mortgage balance | The current payoff amount on all mortgages secured by the relinquished property. | Lender payoff statement (request 30-day payoff) | Using the original loan amount or book balance instead of current payoff |
| Replacement Property | |||
| Replacement property price | The contract price for the replacement property. Must be at least as large as net relinquished proceeds to avoid cash boot. | Purchase agreement | Using appraised value instead of contract price |
| New mortgage amount | The loan you will take on the replacement property. If smaller than the relinquished mortgage, the difference is mortgage boot (taxable unless offset with cash). | Mortgage pre-approval or term sheet | Netting cash and mortgage instead of entering separately |
| Tax Rates | |||
| Federal capital gains rate | 0%, 15%, or 20% depending on your taxable income. Most real estate investors with meaningful gains are at 20%. | IRS tax brackets for LTCG, your CPA | Using ordinary income rate instead of LTCG rate |
| NIIT applicable? | 3.8% Net Investment Income Tax applies if MAGI exceeds $200K (single) / $250K (married filing jointly). | Prior year MAGI, your CPA | Forgetting NIIT -- adds 3.8 points to effective rate |
| State capital gains rate | Your state's rate on real estate gains. California: 13.3% (ordinary income rate). Texas, Florida, Nevada: 0%. | State tax code or your CPA | Using federal rate only and ignoring state |
Boot is any non-like-kind property or cash received in the exchange. Boot causes the corresponding portion of gain to become immediately taxable -- even in an otherwise valid exchange. Understanding boot is the difference between a clean exchange and an expensive surprise at tax time.
Cash boot
Equity shortfall
You reinvest less equity than you took out of the relinquished property. The difference is cash boot -- taxable to the extent of gain. Solution: add cash to the replacement purchase from outside the exchange.
Mortgage boot
Debt relief
You paid off more debt on the relinquished property than you took on for the replacement. The net debt reduction is mortgage boot -- taxable, just like cash received. Solution: take on equal or greater debt on the replacement property.
| Scenario | Relinquished | Replacement | Boot amount | Effect |
|---|---|---|---|---|
| No boot (clean exchange) | $1M sale, $400K mortgage, $600K equity | $1.2M price, $500K mortgage, $700K equity | $0 boot | 100% of gain deferred |
| Cash boot | $1M sale, $400K mortgage, $600K equity | $1.1M price, $500K mortgage, $600K equity | $0 cash boot (equity equal) | No boot -- debt is higher, equity is equal |
| Cash boot (equity shortfall) | $1M sale, $400K mortgage, $600K equity | $1M price, $400K mortgage, $600K equity needed but only $550K from QI | $50K cash boot | $50K of gain taxable |
| Mortgage boot (debt reduction) | $1M sale, $600K mortgage, $400K equity | $900K price, $300K mortgage, $600K equity | $300K mortgage relief boot | $300K of gain taxable |
| Offset mortgage boot with cash | $1M sale, $600K mortgage, $400K equity | $900K price, $300K mortgage. Add $300K cash to purchase. | $0 net boot (offset) | 100% deferred if gain is offset |
Boot is taxed proportionally between recapture and capital gains
If total gain is $380,000 ($120K recapture + $260K LTCG) and you receive $50,000 of boot, the taxable portion is $50,000. The IRS allocates it: first to ordinary income (recapture rate 25%), then to long-term capital gains (20%). So $50K of boot with a recapture amount of $120K means $50K is taxed at 25% (recapture) = $12,500 tax. Our calculator shows this allocation automatically.
Since the TCJA of 2017, Section 1031 applies only to real property. The property must be held for productive use in a trade or business, or for investment. Personal residences, property held for sale (dealer property), and foreign real estate do not qualify.
Investment real estate (all types)
Rental houses, multi-family, apartment buildings, commercial office, retail, industrial, warehouses, self-storage, mobile home parks, farmland, raw land held for investment. All qualify as long as held for investment or business use.
Commercial real estate (owner-occupied)
A building used in your business that you own qualifies -- even if you are the primary tenant. SBA 504-financed owner-occupied commercial real estate frequently uses 1031 exchanges when the business outgrows or moves.
Vacant land
Raw land held for investment or development qualifies. Can be exchanged into improved property and vice versa. "Like-kind" for real estate is extremely broad -- virtually any U.S. real estate for any other U.S. real estate.
Triple-net (NNN) leased property
A popular exchange destination for investors wanting passive income. A property leased to a corporate tenant (Dollar General, McDonald's, CVS) on a long-term NNN lease with minimal management. Exchanges into DSTs (Delaware Statutory Trusts) are also eligible.
Primary residence
Your primary home does not qualify. However, if you have a rental property that you converted to a primary residence (or vice versa), special rules apply -- and you may be able to combine the Section 121 exclusion ($250K/$500K) with a partial 1031. Requires CPA guidance.
Dealer/inventory property (held for sale)
Property held primarily for sale -- by a developer, flipper, or dealer -- does not qualify. The IRS looks at intent and holding period. A property flipped in 90 days will almost certainly fail a 1031 challenge. You must hold property "for investment" to exchange.
Like-kind is extremely broad for real estate
"Like-kind" for real estate means any U.S. real property for any other U.S. real property -- regardless of quality, type, or use. You can exchange a single-family rental for a commercial office building. You can exchange raw farmland for a multi-family apartment complex. You can exchange a strip mall for a self-storage facility. The only limits: both must be U.S. real property (foreign is not like-kind to domestic), and both must be held for investment or business use.
By Day 45, you must deliver a written, signed identification of your intended replacement property(ies). Three mutually exclusive identification rules govern how many properties you may list.
| Rule | Description | Constraint | Best when |
|---|---|---|---|
| Three-property rule | Identify up to 3 properties without regard to their value. Most common rule used. | Maximum 3 properties on the list regardless of value | You have 2-3 strong candidates. Value of each may exceed the relinquished property. |
| 200% rule | Identify any number of properties, but their combined fair market value cannot exceed 200% of the relinquished property's sale price. | Total FMV of identified properties ≤ 2x relinquished sale price | You want to identify more than 3 properties as backup options. |
| 95% rule | Identify any number of properties, but you must close on at least 95% of the total FMV of all identified properties. | Must actually close on 95%+ of identified list's total value | Rarely used -- very high compliance burden. Last resort only. |
The identification must be in writing, signed, and unambiguous. It must specifically describe the replacement property by legal description, street address, or distinguishable name. "A retail property in Dallas" is not sufficient. "123 Main Street, Dallas TX 75201" is sufficient.
Identify more than you need
Use all three slots of the three-property rule. A deal can fall through between Day 45 and Day 180 -- and if it does, you cannot add new properties to your identification list after Day 45. List your primary target plus two backup options. All three must be specifically identified. You do not have to close on all three -- just at least one (or more) within Day 180.
To defer 100% of the gain, the replacement property must meet both tests:
| Test | Requirement | What happens if you fall short |
|---|---|---|
| Value test | Replacement price must equal or exceed the net sale price of the relinquished property (gross proceeds minus selling costs) | Shortfall in value is cash boot -- taxable to the extent of gain |
| Equity test | Equity reinvested in replacement must equal or exceed equity received from the relinquished sale. Equity = proceeds - mortgage payoff. | Shortfall in equity is cash boot -- taxable to the extent of gain |
| Debt test | Mortgage on replacement must equal or exceed mortgage paid off on relinquished, OR the shortfall must be offset with additional cash equity | Net debt reduction is mortgage boot -- taxable to the extent of gain |
Every year you own real estate, you claim depreciation deductions. These reduce your taxable income now -- but at sale, the IRS recaptures those deductions at up to 25%, creating what can be the largest single component of gain on a long-held property.
Annual residential depreciation
Annual depr. = Building value (not land) / 27.5 years
A residential rental property purchased for $500,000 with $100,000 attributed to land has a depreciable basis of $400,000 / 27.5 = $14,545/year. Over 20 years: $290,909 of depreciation claimed. This reduces basis and creates $290,909 of recapture income (taxed at 25%) at a future taxable sale.
Annual commercial depreciation
Annual depr. = Building value (not land) / 39 years
Commercial property uses 39-year straight-line. A $2,000,000 building value depreciates at $51,282/year. Over 15 years: $769,231 of claimed depreciation, all subject to 25% recapture at a taxable sale.
The 1031 exchange defers recapture tax -- it does not eliminate it. When the replacement property is eventually sold in a taxable event, the accumulated recapture from both properties becomes due. Investors who perform repeated 1031 exchanges accumulate a "depreciation cliff" -- a growing deferred recapture liability that follows the property chain until a taxable sale or death.
Cost segregation multiplies the recapture exposure
Cost segregation studies accelerate depreciation by reclassifying building components (flooring, electrical, HVAC, lighting) from 39-year to 5, 7, or 15-year property. This creates larger depreciation deductions earlier -- but also larger recapture at sale. If you used cost segregation, your accumulated depreciation and recapture exposure will be significantly higher than simple straight-line math suggests. Always pull your full depreciation schedule before modeling the exchange.
The most important structural requirement of a 1031 exchange is that the seller cannot receive, control, or have constructive receipt of the sale proceeds between the sale of the relinquished property and the purchase of the replacement property. This is where the Qualified Intermediary (QI) comes in.
Engage the QI before closing
You must have a QI agreement in place before you close on the relinquished property. The QI cannot be you, your spouse, your attorney, your accountant, your real estate agent, or any employee or agent of yours within the past two years. Use a professional QI company -- most charge $750-$1,500 for a standard exchange.
QI receives sale proceeds at closing
At the closing of the relinquished property, the sale proceeds wire directly to the QI's escrow account -- not to you. The QI holds the funds in a segregated, FDIC-insured account. You earn interest on the funds while held. The QI cannot release funds to you under any circumstances within the exchange period.
QI funds the replacement purchase
When you close on the replacement property, the QI wires the funds directly to the closing. You may also add supplemental cash from outside the exchange to the QI account. The QI prepares the exchange agreement, assignment documents, and the IRS-required exchange documentation for your tax return.
Tax return reporting
You report the exchange on Form 8824 (Like-Kind Exchanges), which flows to Schedule D. The form shows the relinquished property, the replacement property, any boot, the gain deferred, and the adjusted basis of the replacement. Your QI will provide the documents needed to complete Form 8824.
QI failure = failed exchange
If a QI goes bankrupt, is fraudulent, or misappropriates funds, your exchange may be treated as a failed exchange -- and all tax comes due, even if you received no cash. This has happened. Use QIs that are members of the Federation of Exchange Accommodators (FEA), carry fidelity bonds and E&O insurance, and maintain funds in segregated institutional accounts. Larger, well-established QI companies (1031 Corp, IPX1031, Asset Preservation) are generally safer than small local operators.
| Type | How it works | Best for | Key complexity |
|---|---|---|---|
| Delayed exchange (standard) | Sell first, then buy within 180 days. The most common structure. QI holds proceeds between transactions. | Most investors in most situations | Finding replacement property within 45 days (identification window) |
| Reverse exchange | Buy the replacement property first, then sell the relinquished property within 180 days. The Exchange Accommodation Titleholder (EAT) holds title to one property. | Hot markets where you need to buy before you can sell; construction situations | Must use an EAT; more expensive ($3,000-$8,000); lender cooperation required |
| Construction / improvement exchange | Use exchange proceeds to build improvements on the replacement property before receiving it. "Build to suit" exchange. QI holds title and funds during construction. | Buying land and constructing or property needing significant improvements | All construction must be complete and the property received within 180 days; strict documentation required |
| DST (Delaware Statutory Trust) | Exchange into fractional ownership of a larger institutional property through a trust structure. Common for investors who want passive income without management. | Investors downsizing management burden; fractional co-investment in NNN, multi-family, or diversified portfolios | Illiquid; no control; typically $100K minimum investment; private placement |
| TIC (Tenants in Common) | Co-ownership in a property with other investors. Each TIC interest is a separate ownership interest eligible for 1031 treatment. | Investors combining exchange proceeds for access to larger institutional properties | IRS Rev. Proc. 2002-22 requirements; up to 35 co-owners; lender restrictions |
| Related-party exchange | Exchanging with a related party (family member, controlled entity). Permitted but with strict conditions: both parties must hold for 2 years after exchange. | Very limited situations | 2-year holding period for both parties; complex IRS rules; audit risk |
The ultimate 1031 strategy is to defer capital gains indefinitely through repeated exchanges and hold the final property until death. When an investor dies holding appreciated real estate, the heirs inherit with a stepped-up basis equal to the property's fair market value at the date of death -- eliminating all accumulated deferred gain.
Step-up basis at death (IRC Section 1014)
Heir's basis = Fair market value at date of death
An investor who bought a property for $200,000, took $150,000 of depreciation, and deferred $600,000 of gain through 1031 exchanges has an adjusted basis of $0 (or near zero). If they die holding a $2,000,000 property, the heir's basis is $2,000,000. The $600,000 of deferred gain plus the $150,000 of recapture is permanently extinguished. The heir can sell immediately with zero tax.
Lifetime deferral and step-up -- example investor
The $900,000 of deferred gain and accumulated depreciation recapture is permanently extinguished at death. The heir inherits free and clear. If they sell immediately, they owe zero federal tax on the entire $2,000,000.
Step-up at risk -- monitor legislation
Congress has periodically proposed eliminating or limiting the step-up in basis at death, which would devastate the lifetime 1031 strategy. The most common proposal: treat death as a recognition event (deemed sale at FMV), with an exemption of $1-5M per person. This has not passed as of 2025, but it remains a recurring legislative risk. Estate planning attorneys and CPAs should monitor for changes, particularly after major elections. Having a trust structure with flexibility to respond is prudent for investors with large deferred gain positions.
Can I do a 1031 exchange on my vacation home or second home?
It depends on how you use it. A vacation home that you rent out for 14 days or more per year and use personally for no more than 14 days per year (or 10% of the days it is rented at fair market rent, if that is greater) may qualify as an investment property for 1031 purposes. In Rev. Proc. 2008-16, the IRS created a safe harbor: hold the property for at least 24 months before the exchange, rent it for at least 14 days per year during that period, and limit personal use to no more than 14 days (or 10% of rental days). If you use the property primarily for personal enjoyment with minimal rental, it is a personal residence and does not qualify.
Can I do a 1031 exchange and then move into the replacement property?
Yes -- with patience. You can convert a 1031 replacement property into your primary residence later, but the IRS requires a holding period. Under the 2004 regulations (Reg. Section 1.121-4), you must hold the replacement property as an investment for at least 24 months before converting to a primary residence. After conversion, you must live in the property for at least 2 of the 5 years before selling to qualify for the Section 121 exclusion ($250K/$500K). Even then, the portion of gain attributable to the 1031 exchange may not qualify for the Section 121 exclusion -- this is complex territory and requires CPA guidance specific to your situation.
What if I cannot find a replacement property in time?
If you fail to identify a valid replacement property by Day 45, or fail to close by Day 180, the exchange fails entirely. The QI returns your proceeds to you, and the full gain becomes taxable in the year of sale -- including all deferred depreciation recapture. There is no partial credit for a failed exchange. If you see Day 45 approaching without a viable property, consult with your QI and CPA immediately. Options: (1) Identify the strongest available option, even if not perfect -- a clean exchange into a "parking" property is better than a failed exchange; (2) DSTs allow identification and closing within very short windows; (3) A reverse exchange may allow you to buy first if you have the cash or credit.
Do I need to use all the proceeds, or can I take some cash out?
You may take cash out -- but any proceeds you receive constitute "boot" and are taxable to the extent of gain. Example: you sell a $1M property with $400K of gain and instruct the QI to send you $50K and reinvest $950K in a replacement property. The $50K is taxable boot -- you pay tax on $50K of gain (split between recapture and LTCG proportionally). The remaining $350K of gain is deferred. If your goal is to take some cash out while deferring as much gain as possible, you can structure a partial exchange intentionally -- just model the tax cost first in the calculator.
Can I exchange multiple relinquished properties for one replacement property?
Yes -- many-to-one exchanges are permitted. You sell multiple relinquished properties and combine the proceeds to purchase a single larger replacement property. Each relinquished property must be separately identified, and the timing rules apply from the closing of the first relinquished property sold. The 45-day identification clock starts from the first closing, regardless of when subsequent relinquished properties close. This structure is common for investors consolidating a scattered portfolio into one larger, better-managed asset.
Can a partnership or LLC do a 1031 exchange?
The entity (LLC, partnership, corporation) does the exchange -- not the individual partners. This creates a common problem: if partners want to "go their separate ways" at the time of the exchange, they cannot -- because the entity is the exchanger, not the individuals. Distributing proceeds to partners before the exchange triggers taxable gain. One solution is a "drop and swap" -- transferring property to tenants-in-common interests before the exchange so each co-owner can do their own separate exchange. This requires planning 12+ months in advance and has its own IRS scrutiny. Another solution is a "swap and drop" -- the partnership exchanges first and then liquidates after a qualifying hold period. Both strategies require CPA and legal counsel well before the sale.
What if my exchange straddles two tax years?
If you close on the relinquished property in one tax year (e.g., November) and the replacement property closes in the next year (e.g., February), the gain is reported in the year the relinquished property closed -- but the Form 8824 is filed in that same year showing the exchange and the deferred gain. The critical action: file a tax return extension (Form 4868) for the year of sale. Without an extension, your exchange deadline is the earlier of Day 180 or your tax return due date (April 15), which may cut your exchange window short. With an extension, you preserve the full 180 days.