1031 Exchange

What is a 1031 Exchange?

A 1031 exchange, also called a like-kind exchange, allows a taxpayer to defer recognizing gain or loss when qualifying real property held for business or investment is exchanged solely for other qualifying like-kind real property.

Under IRC §1031, both the relinquished property and replacement property must generally be held for productive use in a trade or business or for investment. Real property held primarily for sale does not qualify.

A 1031 exchange generally defers tax rather than permanently eliminating the gain. The unrecognized gain is reflected through the basis rules for the replacement property and can affect the tax result when that property is later sold or otherwise disposed of.

What Property Qualifies for a 1031 Exchange?

A property may qualify for a 1031 exchange if it is real property held for investment or for productive use in a trade or business.

Under current federal law, Section 1031 applies only to qualifying real property. Both the relinquished property and replacement property must satisfy the required business or investment holding purpose. (Source)

Examples of property that may qualify include:

• Rental houses

• Apartment buildings

• Commercial buildings

• Office properties

• Warehouses

• Farmland

• Vacant land held for investment

• Land and improvements

• Certain qualifying leasehold interests

• Other interests treated as real property under the Section 1031 regulations

The key eligibility question is why the taxpayer holds the property. Real estate held for long-term investment or business use may qualify, while property held for personal use or primarily for sale does not.

What Property Does Not Qualify for a 1031 Exchange?

Section 1031 generally does not apply to:

• A home held primarily for personal use

• Real property held primarily for sale to customers

• Business equipment that is personal property

• Vehicles

• Stocks

• Bonds and notes

• Most securities

• Partnership interests

• Personal or intangible property that is not treated as real property

The IRS confirms that the like-kind exchange rules apply only to qualifying real property and exclude personal-use real estate, real property held primarily for sale, and personal or intangible property that is not treated as an interest in real property. ((Source))

A dwelling used for both personal and rental purposes requires separate analysis. Under Revenue Procedure 2008-16, the IRS provides a safe harbor for certain dwelling units that meet specified ownership, rental-use, and personal-use requirements.

When is Property “Like-Kind” for a 1031 Exchange?

Property is like-kind when the relinquished and replacement properties are of the same nature or character as real property, even if they differ in grade, quality, physical form, or specific use.

This means the replacement property does not have to be identical to the property given up.

For example, an investor may exchange an apartment building for qualifying vacant land. Both properties can be like-kind even though one is developed and income-producing while the other is unimproved.

The IRS like-kind exchange rules explain that real properties generally qualify based on their nature or character rather than their grade or quality.

One geographic restriction applies: real property located in the United States is not like-kind to real property located outside the United States for Section 1031 purposes.

What is a Deferred 1031 Exchange?

A deferred 1031 exchange occurs when a taxpayer transfers the relinquished property first and receives qualifying replacement property later under an exchange arrangement.

The transaction must remain an exchange of property for property. If the taxpayer actually or constructively receives the proceeds as unrestricted cash before acquiring the replacement property, the transaction can instead be treated as a taxable sale followed by a purchase.

A deferred exchange has two critical deadlines:

Both periods begin when the relinquished property is transferred.

What Is the 45-Day Identification Rule for a 1031 Exchange?

The taxpayer must generally identify replacement property within 45 days after transferring the relinquished property.

Identification must clearly describe the replacement property and comply with the applicable written-identification requirements.

When several possible replacement properties are being considered, three principal identification rules may apply:

• Three-property rule: Identify up to three properties regardless of fair market value.

• 200% rule: Identify more than three properties if their aggregate fair market value does not exceed 200% of the applicable value of the relinquished property.

• 95% rule: If the normal identification limits are exceeded, qualification may remain possible when the taxpayer receives enough identified property to satisfy the applicable 95% threshold.

These rules control which properties can be treated as valid replacement property after the identification period closes.

What is the 180-Day Rule for a 1031 Exchange?

The replacement property must generally be received by the earlier of:

• 180 days after transferring the relinquished property, or

• The due date, including extensions, of the taxpayer’s federal income tax return for the year in which the transfer occurred.

The 180-day period does not begin after the 45-day identification period. Both periods run concurrently from the date the relinquished property is transferred. For transfers late in the tax year, the return due date can shorten the 180-day window. The IRS Instructions for Form 8824 confirm these timing requirements.

What is a Qualified Intermediary in a 1031 Exchange?

A qualified intermediary, or QI, is an independent party commonly used to facilitate a deferred exchange while preventing the taxpayer from having unrestricted access to the proceeds from the relinquished property.

Under the qualified-intermediary safe harbor, the QI enters into a written exchange agreement and facilitates the transfer of the relinquished property and acquisition of the replacement property.

The agreement restricts the taxpayer’s rights to receive, pledge, borrow, or otherwise obtain the benefit of exchange funds during the restricted period. These restrictions help prevent actual or constructive receipt of the proceeds.

Certain persons cannot serve as a QI because they are treated as disqualified persons. These include:

• Related parties under IRC §§267(b) or 707(b) (with 10% substituted for 50%), such as certain family members and entities with more than 10% ownership.

• Persons who acted as the taxpayer’s employee, attorney, accountant, investment banker, or real estate agent/broker within the two years before the transfer.

• Exceptions exist for parties who provided services solely with respect to 1031 exchanges and for routine financial, escrow, or title services.

• A QI is commonly used for deferred exchanges, but it is not required for every possible Section 1031 structure. A direct simultaneous exchange operates differently.

What is Boot in a 1031 Exchange?

Boot is the common tax term for money or non-like-kind property received in addition to qualifying replacement real property.

Boot may include:

• Cash received

• Non-like-kind property received

• Certain net reductions in the taxpayer's liabilities

Receiving boot does not automatically invalidate the entire exchange. Instead, it may cause some of the taxpayer's realized gain to become currently taxable.

Under IRS Publication 544's partially nontaxable exchange rules, gain is generally recognized to the extent of applicable money or non-like-kind property received, limited by the gain realized on the transaction.

Liabilities can also affect the calculation. A net decrease in the taxpayer’s liabilities (for example, being relieved of debt) is generally treated as boot received. A net increase in liabilities (for example, assuming debt on the replacement property) can offset boot received.

What is the Difference Between Realized, Recognized, & Deferred Gain?

Realized gain, recognized gain, and deferred gain represent different stages of the Section 1031 tax calculation.

A taxpayer can therefore realize a substantial economic gain while recognizing only part—or potentially none—of that gain currently.

For a simplified exchange:

Realized gain = Amount realized − Adjusted basis

If taxable boot is received, the recognized amount is then determined under the Section 1031 recognition rules.

The remaining qualifying amount can stay deferred.

How is Replacement Property Basis Calculated After a 1031 Exchange?

In a fully nontaxable exchange, the basis of the replacement property is generally derived from the adjusted basis of the relinquished property, rather than being reset to the replacement property's fair market value.

This carryover-basis structure preserves the effect of the deferred gain.

For example, if investment property with a $300,000 adjusted basis is exchanged solely for qualifying real property worth $500,000, the replacement property's basis would generally begin at $300,000 under the simplified facts.

A partially taxable exchange requires additional adjustments.

The calculation can account for:

• Money paid

• Exchange expenses

• Gain recognized

• Money received

• Non-like-kind property received

• Liabilities assumed

• Liabilities transferred to another party

The IRS Basis of Assets guidance provides the detailed basis rules for like-kind exchanges.

What is a Reverse 1031 Exchange?

A reverse 1031 exchange generally describes a transaction in which replacement property is acquired before the relinquished property is transferred.

Simply buying replacement property before selling the old property does not automatically qualify for Section 1031 treatment.

The IRS provides a safe harbor through a Qualified Exchange Accommodation Arrangement, or QEAA. Under this structure, an Exchange Accommodation Titleholder, or EAT, temporarily holds the applicable property and is treated as its beneficial owner for federal income-tax purposes.

Key QEAA timing rules generally include:

Reverse exchanges require careful sequencing because the acquisition, ownership, identification, financing, and transfer pattern differs from a standard deferred exchange.

How Does Depreciation Recapture Affect a 1031 Exchange?

Depreciation can affect the character and timing of gain even when a transaction otherwise qualifies under Section 1031.

Real estate is commonly Section 1250 property. Ordinary-income recapture under Section 1250 generally concerns additional depreciation, while long-term gain attributable to depreciation can also create unrecaptured Section 1250 gain, which is a separate tax concept.

When Section 1245 or Section 1250 property is involved in a like-kind exchange, special recapture rules can cause some gain to be recognized or preserved for later recognition depending on the assets received and the amount otherwise recognized in the exchange.

For CPA review, these calculations should therefore remain separate:

Adjusted basis → realized gain → recognized gain → character of recognized gain

For related depreciation concepts, see our detailed guide on the Bonus Depreciation Guide.

How is a 1031 Exchange Reported on Form 8824?

A qualifying 1031 exchange is generally reported on Form 8824, Like-Kind Exchanges, including exchanges in which no current gain or loss is recognized.

Form 8824 reports information such as:

• Description of the relinquished property

• Description of the replacement property

• Transfer date

• Identification date

• Date replacement property was received

• Related-party information

• Fair market values

• Money and other property received

• Realized gain

• Recognized gain

• Basis of the replacement property

The IRS Instructions for Form 8824 provide the federal reporting requirements for deferred and related-party exchanges.

Depending on the property and character of taxable gain, additional federal reporting may be required, including Form 4797,Schedule D (Form 1040), or Form 8949 (Sales and Other Dispositions of Capital Assets)

Related-party exchanges can create continuing Form 8824 reporting requirements after the original exchange year.

Do All States Follow Federal 1031 Exchange Rules?

No single state income-tax rule applies to every 1031 exchange.

Section 1031 is a federal provision, but each state determines how federal tax law affects its own income-tax system. State conformity, sourcing rules, reporting requirements, and treatment of deferred gain can therefore differ.

State-level issues can include:

• Whether the state conforms to current federal Section 1031 treatment

• Whether deferred gain remains sourced to the original state

• Additional state forms

• Continuing annual reporting

• Recognition of previously deferred state gain after a later disposition

California illustrates why separate state review matters. When qualifying California real property is exchanged for out-of-state replacement property, taxpayers with deferred California-source gain generally must file Form FTB 3840 and continue the required reporting until the applicable deferred gain or loss is recognized.

For a broader explanation of federal and state tax differences, read a complete guide on Federal vs. State Tax Differences guide.

Which States Limit 1031 Exchanges to Real Property?

For federal income-tax purposes, Section 1031 is already limited to qualifying real property throughout the United States. The state question is whether a state's income-tax law conforms to the current federal rule or applies its own conformity provisions.

California now provides a straightforward example. For taxable years beginning on or after January 1, 2025, California generally conforms to the federal real-property limitation for like-kind exchanges.

Pennsylvania also permits deferral for qualifying like-kind exchanges and directs taxpayers to IRC §1031 for the applicable definition of like-kind property. Its current treatment became effective January 1, 2023.

Because state conformity rules can change by tax year, CPAs should verify the applicable state revenue department's current guidance rather than relying on a static nationwide list.

1031 Exchange Example: Calculating Recognized and Deferred Gain

Assume an investor exchanges rental real estate using these simplified facts:

Assume no liabilities or exchange expenses.

Step 1: Calculate the Realized Gain

$500,000 − $300,000 = $200,000 realized gain

Step 2: Calculate the Recognized Gain

The taxpayer receives $50,000 in cash.

Because the $50,000 received is less than the $200,000 realized gain:

Recognized gain = $50,000

Step 3: Calculate the Deferred Gain

$200,000 realized gain − $50,000 recognized gain = $150,000 deferred gain

Step 4: Calculate the Replacement Property Basis

Under these simplified facts:

$300,000 old adjusted basis + $50,000 recognized gain − $50,000 cash received = $300,000 replacement-property basis

The resulting tax amounts are:

Actual calculations can differ when mortgages, exchange expenses, multiple properties, depreciation recapture, or additional non-like-kind property are involved.

For tax professionals working with real estate clients, CPA Pilot's AI for Real Estate Tax Planning guide covers related real estate tax research and planning considerations.

FAQs About 1031 Exchanges

Is There a Minimum Holding Period for a 1031 Exchange?

IRC §1031 sets no single universal holding period for ordinary qualifying property. The facts must support business or investment intent. Separate safe harbors, such as the rules for certain dwelling units, can impose specific holding and use requirements.

Can Section 121 and Section 1031 Apply to the Same Property?

Yes. A residence converted to qualifying investment property can potentially involve both §121 and §1031. Section 121's ownership, use, depreciation, nonqualified-use, and five-year rules must be applied separately.

Can Related Parties Complete a 1031 Exchange?

Yes, but special rules apply. If either related party disposes of the exchanged property within two years, previously deferred gain or loss can become recognizable unless a statutory exception applies.

Can 1031 Exchange Funds Be Used to Pay Closing Costs?

Certain exchange expenses, including qualifying brokerage, attorney, and deed-preparation costs, can affect replacement-property basis. Property taxes, rent prorations, security deposits, repairs, and similar items are treated separately.

Can a Delaware Statutory Trust Qualify for a 1031 Exchange?

Potentially. An interest in a Delaware Statutory Trust structured consistently with IRS Revenue Ruling 2004-86 may be treated as an interest in real property eligible for §1031 rather than as a partnership interest.