22 Questions in This Hub
- What is a 1031 exchange and how does it work?
- How does the 45-day identification rule work?
- How does the 180-day closing rule work?
- What is a qualified intermediary and do I need one?
- What counts as like-kind property for a 1031?
- What is boot and how does it create taxable gain?
- What is a reverse 1031 exchange?
- What is a build-to-suit (improvement) exchange?
- What is a Delaware Statutory Trust (DST) and how does it fit into a 1031?
- Can I 1031 with a related party?
- Can I 1031 a vacation home or short-term rental?
- Can I convert a 1031 replacement property into my primary residence?
- How does depreciation work on the replacement property after a 1031?
- How much does a 1031 exchange cost?
- Can I 1031 one property into multiple replacement properties?
- What happens if my qualified intermediary goes bankrupt?
- How do I report a 1031 exchange on my tax return?
- Do all states recognize 1031 exchanges?
- When is it better to pay the tax than do a 1031?
- How do 1031 exchanges work when the property is in an LLC?
- What is the swap-til-you-drop strategy?
- How do I track the 45-day and 180-day clocks?
1. What is a 1031 exchange and how does it work? #
A 1031 exchange (named for IRC Section 1031, also called a like-kind exchange) defers capital gains tax and depreciation recapture when you sell an investment property and reinvest the entire net proceeds into another investment property of equal or greater value. The transaction is structured through a qualified intermediary so you never take constructive receipt of the funds.
The mechanics: you close the sale of the relinquished property and the proceeds wire directly to the qualified intermediary's escrow account. You have 45 days from that closing date to identify replacement property in writing, and 180 days from that closing to actually close on the replacement. The replacement carries forward the relinquished property's adjusted basis, plus any new cash you contribute. You report the exchange on Form 8824 with your tax return. Done correctly, the entire gain defers; held to death and stepped up, the deferred gain disappears.
2. How does the 45-day identification rule work? #
Within 45 calendar days of closing the relinquished property, you must identify replacement property in writing, signed and delivered to your qualified intermediary or another person involved in the exchange (other than yourself or a disqualified party). The 45 days are calendar days, not business days, and they include weekends and holidays. There is no extension for hurricanes or family emergencies absent a federal disaster declaration.
Three identification rules are available: the three-property rule (identify up to three properties of any value), the 200% rule (identify any number of properties whose combined fair market value does not exceed 200% of the relinquished property's value), or the 95% rule (identify more than three properties exceeding 200% in value, but you must actually acquire at least 95% of the identified value). Most investors use the three-property rule because it is the simplest. Identifications must be unambiguous (street address or legal description, not just 'a duplex in Cleveland').
3. How does the 180-day closing rule work? #
You must close on the replacement property within 180 calendar days of the relinquished property closing or by the due date of your tax return for the year of the relinquished sale (including extensions), whichever is earlier. The earlier-of clause matters most for sales late in the year: a property sold on November 15 has 180 days until mid-May, but the regular April 15 tax deadline arrives sooner unless you file Form 4868 for an automatic extension to October 15.
The 180-day clock runs concurrently with the 45-day clock; it does not start over. So if you identify on day 44 you have 136 days left to close, not 180. The closing must be on property you formally identified within the 45-day window. Identifying on day 45 and trying to swap in a different property on day 60 fails the exchange and triggers full tax on the gain.
4. What is a qualified intermediary and do I need one? #
Yes, you need one. A qualified intermediary (QI, also called an exchange accommodator) is the third party that holds the sale proceeds in escrow during the exchange so you never take constructive receipt of the funds. Constructive receipt blows up the exchange and triggers full tax. You hire the QI before the relinquished closing; the sale documents reference the QI as the assignee of your interest in the contract.
The QI also receives your written identification within 45 days, holds the funds, wires them to the replacement closing, and produces the substitute documentation your CPA uses to prepare Form 8824. QI fees typically run $700 to $1,500 for a standard delayed exchange, more for reverse or build-to-suit structures. Your attorney or accountant cannot be the QI because they are disqualified parties under the regulations. Use a QI that is bonded, insured, and has segregated client trust accounts.
5. What counts as like-kind property for a 1031? #
For real estate, like-kind is broad: any real property held for investment or productive use in a trade or business is like-kind to any other real property held for the same purpose. A single-family rental can exchange into a small multifamily, a small multifamily into raw land held for investment, raw land into a strip retail center, a strip retail into a Delaware Statutory Trust interest in an apartment building. The form of the real estate does not matter; the use does.
What does not qualify: your primary residence, second homes used personally above safe-harbor limits, dealer property held primarily for resale (such as a flipper's inventory), foreign real estate exchanging into US real estate, and any personal property (vehicles, equipment, art) since the Tax Cuts and Jobs Act limited 1031 to real property only. The relinquished property and the replacement property both have to be held for investment or business use.
6. What is boot and how does it create taxable gain? #
Boot is anything received in an exchange that is not like-kind real property. The two common forms are cash boot (any net proceeds you actually receive instead of reinvesting) and mortgage boot (when the debt on the replacement property is less than the debt on the relinquished property, the difference is treated as cash received).
Boot is taxable up to the amount of realized gain. If you sell for $500,000 with $300,000 of debt and buy a $450,000 replacement with $300,000 of debt, you have $50,000 of cash boot (because you are reinvesting only $450,000 of the $500,000 proceeds), and that $50,000 is taxable. To fully defer, the replacement property must be of equal or greater value AND you must reinvest all of the equity AND you must take on equal or greater debt (or replace the missing debt with cash). Most exchanges fail full deferral because of mortgage boot, not cash boot.
7. What is a reverse 1031 exchange? #
A reverse exchange lets you close on the replacement property before you sell the relinquished property. The QI (often through an exchange accommodation titleholder, EAT) takes title to either the replacement or the relinquished property and parks it until the other side closes. You still have the same 45-day identification and 180-day closing windows, but the timing is inverted.
Reverse exchanges are useful when you find the perfect replacement before your existing property is under contract, and you cannot risk losing it. They are significantly more expensive than forward exchanges (typically $4,000 to $10,000 in QI fees plus loan complications) because the QI carries the parked property and lenders must structure financing around the EAT's ownership. Use them only when the deal economics clearly justify the friction.
8. What is a build-to-suit (improvement) exchange? #
A build-to-suit exchange (also called an improvement or construction exchange) lets you use exchange proceeds to fund improvements on the replacement property within the 180-day window. The QI or an exchange accommodation titleholder takes title to the raw land or partially improved property, contracts for the construction, and conveys the improved property to you before day 180. The value of completed improvements counts toward the replacement value for like-kind purposes.
These work for investors who cannot find a perfect existing replacement and want to build to spec, or to add value before taking possession. The constraints are tight: only improvements actually completed and paid for within 180 days count toward replacement value. Anything still under construction at day 180 does not count. Build-to-suit exchanges are expensive and complex; consult a 1031 specialist before committing to one.
9. What is a Delaware Statutory Trust (DST) and how does it fit into a 1031? #
A Delaware Statutory Trust is a passive, fractional ownership structure that the IRS recognizes as like-kind real estate for 1031 purposes (Revenue Ruling 2004-86). You exchange into a DST interest the same way you would exchange into a deeded property. DSTs typically hold institutional-grade assets (Class A apartments, medical office, industrial) and are syndicated by sponsors who handle all property management.
DSTs are common for investors at the end of an active investing career who want to defer gain on a sale but do not want the operational headache of identifying and operating a new direct property within 45 and 180 days. The trade-offs: no operational control, illiquidity (DSTs typically hold 5 to 10 years), management and acquisition fees that drag yields, and you cannot do another 1031 out of a DST mid-stream (only at sponsor disposition). DSTs are a good landing spot, not a stepping stone.
11. Can I 1031 a vacation home or short-term rental? #
Possibly, under the Revenue Procedure 2008-16 safe harbor for dwelling units. To qualify, the relinquished property must have been held by you for at least 24 months immediately before the exchange, and in each of those two 12-month periods the property must have been rented at fair market rent for at least 14 days, with personal use limited to the greater of 14 days or 10% of days rented. The same test applies to the replacement property going forward.
Pure personal-use second homes do not qualify because they are not held for investment. Properties used heavily for short-term rentals on Airbnb or VRBO with documented business intent generally do qualify if the personal-use limits are respected. Document everything: rental days, fair-market rent comparables, and personal-use days, because the IRS scrutinizes these exchanges and the safe harbor is the cleanest defense.
12. Can I convert a 1031 replacement property into my primary residence? #
Yes, but the rules around how long you must hold and rent it before moving in are strict. The safe harbor under Revenue Procedure 2008-16 requires that the replacement property be held as a rental for at least 24 months following the exchange, with the same 14-day rental and 14-day personal-use limits in each year. After meeting the safe harbor you can convert it to a primary residence.
Once you have lived in the property as your primary residence for at least 5 years total (since the exchange closing) and used it as your primary residence for 2 of the most recent 5 years, you can sell and use the Section 121 primary residence exclusion ($250,000 single, $500,000 married). However, depreciation recapture on the rental period still owes, and a portion of the gain attributable to the 1031 deferral may not qualify for full Section 121 exclusion under Section 121(d)(10). Plan the timeline before you exchange.
13. How does depreciation work on the replacement property after a 1031? #
The replacement property carries forward the adjusted basis of the relinquished property (original basis minus accumulated depreciation), plus any new boot you paid in (additional cash, additional debt assumed). Your future depreciation deduction has two components: the carryover basis continues depreciating on its original schedule (the remaining life of the relinquished property), and the new boot basis starts a fresh 27.5 year schedule from the date of acquisition.
This split-basis method is mandatory under the regulations unless you elect to treat the entire basis as new (Reg 1.168(i)-6(i)), which can simplify schedules but typically reduces total depreciation. Most CPAs default to the split-basis method because it preserves more current-year deduction. Keep clear records of the carryover basis, the boot basis, and each component's remaining life. This is an area where DoorVault's per-property basis tracking matters more than the average property because the schedule never matches a single fresh purchase.
14. How much does a 1031 exchange cost? #
A standard delayed exchange (sell first, buy within 180 days) typically costs $700 to $1,500 in qualified intermediary fees. Reverse exchanges run $4,000 to $10,000 because the QI carries title to one of the properties and the structure is more complex. Build-to-suit exchanges land in the same range as reverse exchanges, sometimes higher depending on construction complexity.
On top of QI fees you have normal closing costs on both transactions (title insurance, escrow, recording, lender fees if you finance), state transfer taxes, and possibly a 1031 attorney if your QI does not include legal review. Total all-in transaction cost on a delayed exchange of two $500,000 properties is typically $15,000 to $30,000 between both closings. Compare that to the deferred federal capital gain plus depreciation recapture; on a property with $200,000 of gain, the deferred tax often exceeds $40,000 to $60,000, which means even an expensive exchange clears the bar.
15. Can I 1031 one property into multiple replacement properties? #
Yes. The 1031 rules permit one-to-many and many-to-one exchanges as long as the identification rules are followed (typically the three-property rule or the 200% rule). A common pattern is selling one large property (say a $1.2M small commercial building) and buying two or three smaller residential rentals to diversify. The exchange clock is the same: 45 days to identify all replacement properties, 180 days to close all of them.
All replacement properties combined must be of equal or greater value than the relinquished property to fully defer gain. If you only deploy $900,000 of the $1.2M sale into replacements, the unspent $300,000 is cash boot and triggers tax. Many-to-one exchanges (selling several smaller properties and consolidating into one larger building) work the same way but require careful coordination of closing dates so the 45-day clock starts from the first relinquished closing.
16. What happens if my qualified intermediary goes bankrupt? #
This has happened to investors in past failed QIs and the losses were severe. If a QI goes bankrupt while holding your exchange funds, you become an unsecured creditor and may recover only cents on the dollar. The exchange typically fails (because you cannot complete the purchase), the gain becomes fully taxable, and you owe the tax even though the funds are gone.
Mitigation: choose a QI that segregates client funds in qualified trust accounts (not commingled with operating funds), carries fidelity bond and errors-and-omissions insurance with high limits, has been in business for at least 10 years, and is a member of the Federation of Exchange Accommodators. Review the QI's audited financials and ask explicitly how funds are held. The largest QIs use third-party qualified escrow with major banks, which adds a layer of protection. Cheap QIs that hold funds in their own operating accounts are the riskiest.
17. How do I report a 1031 exchange on my tax return? #
You file Form 8824 (Like-Kind Exchanges) with your tax return for the year the relinquished property was sold. Form 8824 reports the description of both properties, dates, gain realized, gain recognized (boot), basis carryover, and adjusted basis of the replacement property. The deferred gain is computed on the form and reduces the basis of the replacement property, ensuring the tax is paid eventually unless you exchange again or step up at death.
You also report any recognized gain (cash boot or mortgage boot) on Schedule D and Form 4797. The replacement property begins reporting on Schedule E in the year it is acquired with the carryover basis (and any new boot basis on a separate depreciation schedule). Keep the closing statements for both transactions, the QI's exchange agreement, the identification notice, and Form 8824 together in your records for at least the holding period of the replacement plus three years after disposition.
18. Do all states recognize 1031 exchanges? #
Most do, but not all, and the details matter. California, Oregon, Massachusetts, and Montana have clawback rules that track the deferred state gain when an investor exchanges out of state and then sells the replacement property elsewhere. California in particular requires annual filings (Form FTB 3840) for as long as the deferred gain remains, and state tax becomes due when you eventually sell without another 1031.
Pennsylvania historically did not recognize 1031 deferral at the state level, treating exchanges as fully taxable for state purposes (this conformed to federal in 2023 for transactions after that year). Check your state's current treatment before assuming federal deferral mirrors at the state level. If you are exchanging across state lines and one of the states has clawback, model the eventual state tax exposure as part of the exchange decision.
19. When is it better to pay the tax than do a 1031? #
When the replacement property is worse than the relinquished property and you are exchanging only to avoid tax. A common trap: investor sells a stabilized $600,000 cash-flowing duplex with $200,000 of deferred gain, then panics during the 45-day window and identifies a marginal $650,000 property in a market they do not know just to avoid the $40,000 federal tax bill. Two years later the replacement underperforms and the all-in cost (lost cash flow, vacancies, distance management) exceeds the tax that would have been paid.
Other reasons to pay: you have suspended passive losses on Form 8582 that fully release on the disposition (the suspended losses offset the gain), you are in a low income year and the rate is lower than future rates likely, or you genuinely want to exit real estate rather than reinvest. The 1031 is a deferral tool, not a free lunch. If the replacement does not stand on its own merits as the right next investment, pay the tax and move on.
20. How do 1031 exchanges work when the property is in an LLC? #
Single-member LLCs are disregarded for federal tax purposes, so the LLC and its owner are treated as the same taxpayer for 1031 purposes. The exchange happens at the LLC level, and the relinquished and replacement properties can be in different single-member LLCs of the same owner without breaking the exchange.
Multi-member LLCs (taxed as partnerships) are trickier. The partnership itself, not the individual members, is the taxpayer for 1031 purposes. If some members want to cash out and others want to defer, the partnership has to use a structure like a drop and swap (distribute the property to the members as tenants in common before sale, so each member can independently exchange or pay tax) or a swap and drop (partnership exchanges into the new property and later distributes interests). Both have IRS challenge risk and require careful timing. Talk to a 1031 specialist plus your CPA before structuring any partnership-level exchange.
21. What is the swap-til-you-drop strategy? #
Swap-til-you-drop is the long-term tax strategy of doing 1031 exchanges throughout your investing career, never selling for cash, and holding the final portfolio at death. Heirs receive a stepped-up basis to the fair market value as of the date of death under IRC 1014, which wipes out all of the deferred capital gain and depreciation recapture you accumulated over decades. The deferred tax becomes permanent tax savings.
The strategy requires discipline: every disposition must be exchanged into qualifying replacement property within the 45 and 180 day windows, every basis must be tracked carefully across exchanges, and you commit to never taking constructive receipt of the cash. Estate-tax exposure is a separate issue (the property's full value is included in the gross estate even though the income tax disappears), so high net worth investors pair the strategy with estate planning. Combined with cost segregation and bonus depreciation in the high-bonus years, this is the most tax-efficient approach available to a long-term real estate investor.
22. How do I track the 45-day and 180-day clocks? #
Mark both dates on the calendar the moment the relinquished property closes, plus reminder alerts at day 30 (review identification candidates) and day 40 (final identification deadline approaching) for the 45-day clock, and day 150 and day 170 for the 180-day clock. The QI will track the deadlines too, but ultimate responsibility is yours. Missing either deadline by even one day fails the exchange and triggers full tax.
DoorVault's 1031 exchange timer logs the relinquished closing date, computes the identification and closing deadlines, and alerts on milestones so you do not have to manage it from a calendar. Pair the timer with a written identification template you update during the 45-day window; do not draft identifications under deadline pressure on day 44. The tool is free and does not require a DoorVault account.