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Everything You Need To Know About 1031 Exchanges

Are you a real estate investor looking to defer capital gains taxes when selling your next property? Well, you're in luck! With the 1031 exchange tax deferral strategy, you can do just that, even as a newbie real estate investor.

In the following sections, we'll review all you need to know about 1031 exchanges, their pros and cons, and when you should consider doing a 1031 exchange.

What is a 1031 Exchange?

You may have heard of the terms; like-kind exchange, starker exchange, deferred 1031 exchange, or even delayed exchange. But they all point to one term: 1031 exchange.

So, what is a 1031 exchange?

A 1031 exchange is a useful tax saving tool that allows you to avoid paying capital gains taxes when you exchange an investment property used "for productive use in a trade or business" or for investment and reinvest the proceeds in similar real estate within certain timeframes.

Here's how it works:

When you sell an investment property, you can defer paying capital gains taxes by using the sale proceeds to buy replacement property or properties of "like-kind." The IRC Section 1031 defines like-kind properties as properties with the same nature or character, even if they differ in quality or grade. For example, you can exchange vacant land for a commercial building.

Here are some examples of properties that qualify for a 1031 exchange:

  • Rental properties, such as residential, commercial, industrial, or retail properties.
  • Land, including farmland or raw land.
  • Non-real estate assets like oil and gas royalties or a ranch.

Check Necessary Documents.

While your replacement property may qualify as like-kind, to complete a 1031 exchange, there are several requirements that you and your property must meet to reap the benefits that come with doing a like-kind exchange.

  • The properties involved in the exchange must be used for investment purposes or in a trade or business. Your primary residence or second home may not qualify for a 1031 exchange, especially if they weren't used for trade, business, or investment purposes.
  • The properties being exchanged must be of like-kind, meaning properties with similar characteristics. For instance, a commercial property can be exchanged for another commercial property.
  • Within 45 days from the sale of the relinquished property, you must identify the replacement property or properties you intend to buy.
  • You must receive the replacement property within 180 days from the sale of the relinquished property or by the tax return due date, whichever comes first.
  • When doing a like-kind exchange, you must designate a qualified intermediary who will hold the sale proceeds and facilitate the exchange process.
  • The market value of your replacement property must be equal to or greater than the market value of the relinquished property. If there is any cash left over from the sale of the initial property, known as the "boot," it will be subject to capital gains tax.

Types of 1031 Exchanges

There are four main types of 1031 exchanges that you should be aware of:


Simultaneous exchange: In this type of exchange, both the relinquished property and the replacement property are closed simultaneously, meaning they are bought and sold on the same day.



Delayed exchange: With a delayed exchange, you first sell the relinquished property and then acquire the replacement property within a specified timeframe, usually within 180 days.



Reverse exchange: In a reverse exchange, you acquire the replacement property before selling the relinquished property. And the acquired property must be held in a separate entity, such as a separate LLC, and you cannot own both properties simultaneously.



Build-to-suit exchange: Also known as improvement exchange, this type of exchange allows you to use the sale proceeds of your old property to construct or improve a replacement property within the 180 days’ timeline.


Before doing a 1031 exchange, it is important that you fully understand the various types of exchanges and their set of rules and choose the one that works best for your situation.

How a Typical 1031 Exchange Process Works

To help you understand how a typical 1031 exchange process works in reality, here is a detailed example:

  • The current property is a multifamily building with a cost basis of $2 million.
  • The current market value of the building is $4 million.
  • You have no outstanding mortgage on the property.
  • All fees, including commissions and escrow fees, are included in the original purchase price.
  • Your capital gains tax rate is 20%.

Selling the property without doing a 1031 exchange:

In this particular example, you are tired of owning the property and decide to sell it outright without doing a 1031 exchange. By deciding to sell the property, the IRS requires you to pay capital gains tax on the sale, which would be: Sale price ($4,000,000) minus cost basis ($2,000,000), which equals gain ($2,000,000).

Since you made a gain, you'll need to pay capital gain taxes on the realized gain. That is, realized gain ($2,000,000) multiplied by the 20% capital gains tax rate, which equals $400,000. So, by outright selling your property without doing a 1031 exchange, you are liable for a capital gain tax of $400,000 plus other tax liabilities.

Selling the property using a 1031 exchange:

Now, in this scenario, you decide to sell the property using a 1031 exchange to avoid paying over $400,000 in capital gain taxes. Firstly, you will need to sell your current property and send the sale proceeds of $4,000,000 directly to a qualified intermediary.

Next, you have 45 days from the sale of your old property to identify a replacement property or properties. Using the three property rules, you identified, a $4 million multifamily property, a strip mall for $4.5 million, and an apartment building for $3.5 million.

Finally, within 180 days of the sale of your old property, you will need to take one of the following actions:

  • Acquire the multifamily property on sale for $4 million and defer paying capital gains taxes of around $400,000.
  • Purchase the strip mall for $4.5 million and defer paying capital gains taxes.
  • Purchase the apartment building for $3.5 million and pay capital gains taxes on the realized gain (boot) of $500,000.
  • Or, you can end up purchasing the $3.5 million apartment building in addition to a vacant land worth $500,000 to avoid paying capital gain taxes.

1031 Exchange Rules of Property Identification and Timelines

If you're keen on doing a 1031 exchange, there are several rules and timelines you must know when identifying your potential replacement properties. These rules and timelines cut across the various exchange types and can either make or mar your exchange.

  • 45-Day Rule: Once you sell your property, you have 45 days to find potential replacement properties. This period begins on the day of the property sale. For example, if you sold your property on January 1st, you would have from January 2nd to February 15th to identify replacement properties.
  • 180-Day Rule: The 180-day rule is the overall timeframe for completing the entire exchange process. It includes selling your property and acquiring the replacement property or properties. So, if you sold your property on January 1st, you would have from January 2nd to June 30th to complete the exchange.
  • Three-Property Rule: You can identify up to three potential replacement properties, regardless of their fair market value. For instance, you might select Property A at 123 Main Street, Property B at 456 Elm Avenue, and Property C at 789 Oak Lane as your potential replacement properties.
  • 200% Rule: With the 200% rule, the combined value of the replacement properties you identify cannot be more than twice the sale price of your original property. For example, if you sold your property for $500,000, the total value of the replacement properties you can identify should not exceed $1,000,000.
  • 95% Rule: You can identify any number of replacement properties as long as the total value of the properties you acquire is at least 95% of the total value of all the replacement properties you identified. Let's say you identified five replacement properties with a total value of $1,200,000. To meet the 95% rule, the replacement properties you acquire should have a total value of at least $1,140,000.

Calculate Your Transaction Deadlines

Use our 1031 deadline calculator to figure your deadlines.

When Should a 1031 Exchange Be Used?

Knowing when to do a 1031 exchange is important for the success of your transaction. Here are several situations when you should consider doing a 1031:

  • When you want to upgrade to a larger or better investment property.
  • When you want to sell an investment property and use the money to purchase multiple real estate properties.
  • When you want to diversify your investment portfolio by exchanging into different classes of properties.
  • When you want to postpone paying capital gains taxes on the sale of an investment property.

Girl with some good ideas.

Pros and Cons

Like any other financial investment, doing an exchange comes with its fair share of pros and cons. Here are some of the advantages:

  • You can delay paying capital gains taxes.
  • You have the opportunity to reinvest in a property that is equal to or of greater value.
  • You can upgrade to a more profitable investment property.
  • It allows you to diversify your investment portfolio.

However, there are also a few drawbacks you should consider:

  • You will need to find a qualified intermediary to facilitate the exchange.
  • Strict procedures, timelines, rules, and regulations
  • If the exchange is not completed properly, there is a risk of having to pay taxes.
  • If the replacement property is worth less than the original property, you may have to pay taxes on the difference in value.

If you're considering a 1031 exchange, it's important to carefully evaluate the pros and cons to determine if it's the right decision for you.

Josephine Shagaya headshot.

About The Author


Josephine Shagaya is a writer who specializes in real estate, 1031 exchanges, and mortgage topics. She has a deep understanding of these subjects and uses her knowledge to help readers navigate the complexities of property investment. With a Bachelor's degree in Finance from Georgia State University and work experience in the US Real Estate industry, Josephine through her writings aims to make complicated topics easily understandable for both beginners and experienced investors.

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