Section 1031 exchanges: the complete guide to deferring gain on real estate

A Section 1031 like-kind exchange lets an owner of investment or business real estate sell one property and acquire another without recognizing the built-in gain, so long as the transaction is structured as an exchange rather than a sale followed by a purchase. Since the Tax Cuts and Jobs Act, the provision applies only to real property — equipment and other personal property were removed from the statute for exchanges after 2017. The deferred gain does not disappear; it is carried into the replacement property through a reduced basis and collected whenever that property is sold outside another exchange.

The mechanics are unforgiving. Two statutory deadlines — 45 days to identify replacement property, 180 days to close — run from the sale of the relinquished property with no grace, and the taxpayer must never touch the sale proceeds. Get the structure right and a lifetime of serial exchanges, capped by a basis step-up at death, can defer gain permanently. Get it wrong and the entire gain, including depreciation recapture, lands in the year of sale.

What qualifies as like-kind after the TCJA?

Section 1031(a) requires real property "held for productive use in a trade or business or for investment" exchanged for real property of like kind held for the same purposes. "Like kind" refers to the nature of the property, not its grade or quality — raw land for an apartment building qualifies; an office tower for a farm qualifies; a 30-year leasehold with at least 30 years remaining qualifies against a fee interest under Treas. Reg. §1.1031(a)-1(c). Final regulations issued in 2020 (Treas. Reg. §1.1031(a)-3) define real property for this purpose, generally including land, inherently permanent structures, and structural components.

What does not qualify:

• Personal-use property. A primary residence or a vacation home used mostly personally is not held for investment. (Rev. Proc. 2008-16 provides a safe harbor for vacation properties with limited personal use and genuine rental history.)
• Dealer property. Inventory held primarily for sale — a flipper's houses, a developer's lots — is excluded by Section 1031(a)(2). The dealer-versus-investor line matters as much here as it does for capital-gain treatment.
• Personal property of any kind, post-TCJA. A cost segregation wrinkle follows from this, discussed below.
• Partnership interests. An interest in a partnership that owns real estate is not real property; this drives the "drop and swap" structuring that examiners scrutinize.
• U.S. for foreign real property — Section 1031(h) treats them as not like-kind.

How do the 45-day and 180-day rules work?

Almost no modern exchange is a simultaneous swap. The deferred-exchange safe harbors in Treas. Reg. §1.1031(k)-1 allow a sale today and a purchase months later to be treated as one exchange, subject to two calendar-day clocks that both start when the relinquished property closes:

The two statutory deadlines, and the identification limits that go with them.

The deadlines are rigid. They include weekends and holidays, they are not extended by closing delays or financing failures, and the only relief is IRS disaster postponement under Rev. Proc. 2018-58. A taxpayer whose 180th day falls after the unextended return due date (common for late-year sales) must extend the return to get the full period — filing in March cuts the exchange period short.

What does a qualified intermediary actually do?

The core doctrinal risk in a deferred exchange is constructive receipt: a taxpayer who can touch the sale proceeds has sold, not exchanged. The qualified intermediary (QI) safe harbor of Treas. Reg. §1.1031(k)-1(g)(4) solves this. The QI — a third party who is not the taxpayer's agent, attorney, accountant, or employee within the prior two years — enters the exchange agreement, is assigned the sale contract, receives the proceeds, and uses them to acquire the replacement property, which is deeded directly to the taxpayer.

Three practice points. First, the QI must be in place before the relinquished closing; proceeds that hit the taxpayer's account even briefly end the exchange. Second, the exchange agreement must limit the taxpayer's rights to receive money until the exchange terminates (the "(g)(6) limitations"). Third, QIs are lightly regulated in most states — QI failures during the 2008–09 period cost taxpayers both their funds and their deferral, so segregated accounts and a substantial, bonded intermediary are worth the fee.

Boot: how partial deferral gets taxed

An exchange need not be perfectly balanced. Anything received that is not like-kind real property is boot, and boot triggers recognition of realized gain — up to, but not beyond, the total gain. Boot comes in two forms:

• Cash boot. Proceeds not reinvested. Taking $100,000 out of the exchange recognizes $100,000 of gain (assuming at least that much realized gain).
• Mortgage boot. Debt relief. If the mortgage retired on the relinquished property exceeds the debt placed on the replacement, the excess is treated as money received under Reg. §1.1031(b)-1(c) — though it can be offset by adding cash. New debt exceeding old debt does not create negative boot or shelter cash received.

The planning rule of thumb: to defer everything, trade equal or up in both value and equity. And recognized boot gain is not automatically favorable-rate gain — it is characterized under the normal rules, so unrecaptured Section 1250 gain (25% rate) and any Section 1245 recapture surface first.

A worked example

A $2.0M sale rolled into a $2.4M replacement, with $50,000 of cash taken out.

The replacement basis under Section 1031(d) is the old basis ($800,000), plus new money invested ($450,000 of additional equity and debt beyond the exchange proceeds, net), plus gain recognized ($50,000), minus money received ($50,000) — equivalently, cost of $2.4M less $1.15M deferred gain. The $50,000 recognized is taxed first as unrecaptured §1250 gain at up to 25%, since accumulated depreciation far exceeds it.

How does the replacement property depreciate?

The exchanged-basis rules of Treas. Reg. §1.168(i)-6 split the replacement property in two. The carryover basis (the old adjusted basis) continues depreciating on the relinquished property's remaining schedule — same recovery period, same convention, as though the old building kept going. The excess basis (new money) is treated as newly placed-in-service property: a fresh 27.5- or 39-year life, and eligibility for cost segregation and — for property acquired after January 19, 2025 — permanent 100% bonus depreciation on the short-life components carved out of it. Taxpayers may instead elect out of §1.168(i)-6 and treat the entire basis as new property, which restarts the long clock but simplifies the books.

This is where cost segregation and Section 1031 interact, and the interaction cuts both ways. A study on the excess basis of the replacement property is clean value. But a study performed on the relinquished property shortly before an exchange can backfire: post-TCJA, the 5- and 7-year components are personal property that no longer qualifies for like-kind treatment, and Section 1245 recapture on them cannot be deferred by an exchange of real property alone. The full analysis is in cost segregation and 1031 exchanges, and the timing question belongs in the same conversation as when to commission a study.

Related parties, reverses, and improvement exchanges

Related parties. Section 1031(f) imposes a two-year holding rule on direct exchanges between related parties (as defined in §§267(b) and 707(b)): if either side disposes of its property within two years, the deferred gain springs back. Worse, acquiring replacement property from a related party through a QI is treated as a basis-shifting circumvention under §1031(f)(4) and Rev. Rul. 2002-83, and generally fails unless the related seller is doing its own exchange. Selling relinquished property to a related party is comparatively safe.

Reverse exchanges. When the replacement must close before the relinquished property sells, Rev. Proc. 2000-37 provides a safe harbor: an exchange accommodation titleholder (EAT) "parks" one property for up to 180 days. Reverse exchanges are more expensive — the EAT takes title, financing is awkward — but they rescue transactions where the purchase cannot wait.

Improvement (build-to-suit) exchanges. Exchange funds can pay for construction on the replacement property, but only improvements completed while the EAT holds title count — the taxpayer cannot exchange into improvements on land it already owns (Bloomington Coca-Cola doctrine), and the 180-day limit makes major construction impractical.

When a 1031 exchange is the wrong answer

Neutrality demands the list. An exchange makes little sense when the gain is small relative to transaction costs (QI fees, legal, and the friction of the deadlines); when the taxpayer has suspended passive losses or an expiring capital loss carryforward that would absorb the gain at no cost — see the passive activity rules on how a full disposition releases suspended losses that an exchange keeps locked; when the seller actually wants liquidity, since boot planning to extract cash erodes the deferral; or when basis step-up at death is near enough that a sale would never happen anyway. Dealers cannot use it at all. And the reduced carryover basis means less depreciation going forward — deferral has a carrying cost measured in foregone deductions.

The exchange is reported on Form 8824 for the year of the transfer, and depreciation on both basis layers runs through Form 4562. The statutory text of Section 1031 is short and worth reading directly in the Internal Revenue Code; nearly all of the machinery lives in the regulations.