A Beginners Guide to 1031 Exchanges

The replacement property must be equal or greater in value. Paying taxes on a successful real estate transaction can significantly reduce an investor’s return. Fortunately, a well-established legal strategy allows investors to defer capital gains taxes while continuing to grow their real estate portfolio: the Section 1031 Exchange. This exchange permits the deferral of taxes when an investment or business-use property is exchanged for another qualifying “like-kind” property.

Whether you are considering your first 1031 exchange or revisiting the process as a seasoned investor, this guide outlines the key requirements, timelines, and considerations necessary to execute a compliant and strategic exchange—minimizing tax exposure and maximizing long-term investment growth.

What Is a 1031 Exchange?

A 1031 exchange, named after Section 1031 of the Internal Revenue Code, allows you to sell an investment or business-use property and reinvest the proceeds into another like-kind property—without paying capital gains taxes at the time of sale. Instead, you defer the taxes, rolling your gains into the next investment. This is a tax deferral, not a tax elimination. If you eventually sell the new property without doing another exchange, those deferred taxes will come due. But in the meantime? You keep more cash working for you.

Core Requirements (a.k.a. The IRS Rulebook You Can’t Ignore)

To reap the full benefits of a 1031 exchange, timing and structure are everything. Miss a step, and the IRS will come knocking—with a tax bill in hand. Watch the Clock. If you miss either deadline—even by a day—you lose the tax deferral.

• 45-Day Identification Period: After selling your original (relinquished) property, you have exactly 45 calendar days to identify potential replacement properties.
• 180-Day Exchange Period: You must close on the new property within 180 days of the original sale or by the date your tax return is due (whichever comes first).

Use a Qualified Intermediary (QI). You can’t touch the money. Not even for a second. A Qualified Intermediary holds the sale proceeds and uses them to purchase the replacement property on your behalf. Choose a reputable QI, and get a written exchange agreement before closing the sale of your property. Like-Kind Property—This term is broader than it sounds. You don’t have to swap an office for another office. 

This exchange can also include fractional ownership structures like Delaware Statutory Trusts (DSTs) and Tenancy in Common (TICs). These let investors defer taxes while shifting from full property ownership to partial, passive investment:

• DSTs offer shares in large, professionally managed real estate—ideal for hands-off investors.
• TICs provide deeded ownership shared with others, with more involvement but similar tax benefits.

Much like swapping properties, these structures allow investors to adjust the level of control and effort in their portfolio while maintaining 1031 eligibility.

Value and Equity Rules

To defer taxes fully:

• The replacement property must be equal or greater in value.
• You must reinvest all net sale proceeds.
• You must take on equal or greater debt or offset the difference with additional cash.

Any leftover cash (“boot”) or reduction in debt could trigger a partial taxable gain. The government allows you to defer capital gains tax in a 1031 exchange because you’re not really “cashing out”—you’re just continuing your investment in a similar type of asset (real estate for real estate). But, if you take cash out (boot), you’ve actually received something of value—which the IRS sees as constructive gain. Additionally, if you take on less debt in the new property and don’t replace it with cash, you’re economically better off—so that part is taxable, too.

Types of Boot

• Cash Boot: If you sell a property for $1 million and only reinvest $950,000 into the new property, the $50,000 you keep is cash boot and is taxable.

• Mortgage Boot (Debt Relief): If you had a $500,000 mortgage on the old property but only take on a $400,000 mortgage on the new one—and don’t offset that difference with cash—you’ve received $100,000 in debt relief. That difference is also treated as boot and can be taxable.

Popular Exchange Structures

There are a few ways to structure a 1031 exchange depending on your situation:

• Delayed Exchange: The most common. Sell first, buy second (within 180 days).
• Reverse Exchange: Buy the new property before selling your current (relinquished) property. This is useful when you have found the ideal replacement but haven’t sold your current property yet or if you’re in a competitive market and need to act quickly. A special entity called an Exchange Accommodation Titleholder (EAT) temporarily holds the new property, and you must then sell your old property within 180 days to complete the exchange.
• Build-to-Suit Exchange: Use exchange funds to improve the replacement property (timing is tight here)

Risks and Pitfalls

A 1031 exchange isn’t without its share of curveballs. Finding a qualifying property in time can be tough, and if you miss a deadline for any reason, the exchange is lost, and your sale proceeds will be taxable. Due diligence matters. A bad replacement property means deferred taxes…and deferred headaches. The pressure to meet the deadline for a successful exchange can cause investors to buy a property they otherwise would not have or push through Diligence and overlook issues they may have otherwise caught. Be careful to make sure the replacement property is desirable for reasons other than the tax savings achieved through the 1031 exchange. 

Conclusion

Most people don’t think of tax law as a source of opportunity—but for real estate investors, the Section 1031 exchange can be a game changer. It lets you defer capital gains taxes, grow your investment portfolio, and even move away from the day-to-day hassles of managing property. In short, it’s a smart tool for building wealth and planning for the future. That said, the rules can be tricky, so it’s important to have the right legal support.