Understanding 1031 Exchange Basics

What is a 1031 Exchange?

A 1031 exchange — named after Section 1031 of the Internal Revenue Code — allows you to sell one investment or business property and buy another like-kind property while deferring capital gains taxes that would normally be due at sale.

This helps investors:

• Preserve equity
• Reposition into stronger or more strategic properties
• Compound long-term wealth without immediate tax erosion

Key Requirements

To qualify for a 1031 exchange:

• The property must be held for investment or business purposes
• You must identify replacement property within 45 days
• You must complete the exchange within 180 days (or by your tax filing due date, if earlier)
• You must use a Qualified Intermediary (QI) — you cannot receive or control sale proceeds

How the 1031 Exchange Process Works

1. Plan early: Engage your QI and CPA before opening escrow.
2. Sell your property: Proceeds go directly to the QI.
3. Identify replacement properties: Submit written identification to your QI within 45 days.
4. Perform due diligence: Inspect, negotiate, and secure financing.
5. Acquire replacement property: QI wires funds to close within 180 days.
6. Report the exchange: File IRS Form 8824 with your tax return.

Timeline Tip:
Day 1 starts the day after closing. The 45-day and 180-day deadlines are strict and almost never extendable.

The 45-Day Identification Rules

You must identify replacement property using one of the IRS-approved methods:

• 3-Property Rule: Identify up to 3 properties of any value
• 200% Rule: Identify any number of properties, as long as total value ≤ 200% of the relinquished property
• 95% Rule: Identify any number of properties, but you must close on at least 95% of the total value identified

Avoiding Boot: Replacing Equity and Debt

To fully defer taxes, you must:

• Buy property of equal or greater value
• Reinvest all net equity (sale proceeds)
• Replace equal or greater debt — or contribute cash to offset any reduction in debt

Any funds or debt not reinvested is considered boot, which is generally taxable.