What Are the IRS 1031 Exchange Rules?
To qualify, a 1031 exchange must meet several strict rules:
- Investment or business use only: Both the relinquished property and the replacement property must be held for investment or productive use in a trade or business. Personal residences generally do not qualify (unless you convert them to a rental before the exchange). Swapping one personal home for another is not allowed. Likewise, property held primarily “for sale” (like inventory or a flip) is ineligible.
- Like-kind properties: The properties must be of like-kind. For real estate, “like-kind” is broadly defined: almost any real property is like-kind to any other real property, provided both are in the U.S. For example, an apartment building is generally like-kind to another apartment building, a rental house, vacant land, or even commercial real estate. Improved or unimproved land are considered like-kind, regardless of differences in quality. (One exception: U.S. real property is never like-kind to foreign real property.)
- Same taxpayer/entity: The taxpayer who sells the old property must be the same taxpayer who buys the replacement property. For example, if John Doe sells a property, John Doe (or the same LLC/partnership that owned the old property) must be on the purchase of the new one. You can’t sell in one name and buy in a different name or entity and still qualify.
- Use of a Qualified Intermediary: You cannot receive the cash proceeds from the sale of the old property. The proceeds must be held by a qualified intermediary (or escrow agent) who then uses those funds to acquire the replacement property. If you touch the money, the exchange fails.
- Equal or greater value: To fully defer tax, the total value of the replacement property (and any debts assumed) must be equal to or greater than that of the relinquished property. If you take any cash or non-like-kind property out of the exchange (known as boot), that portion will be taxed (see “Boot” below).
- Timely identification and exchange: You must follow the strict timing rules (see next section). The 45-day and 180-day deadlines are inflexible (absent a special disaster relief order from the IRS). If you miss a deadline, the exchange fails and you owe tax on the sale as if no exchange occurred.
- Reporting: You must report the exchange to the IRS using Form 8824 on your tax return for the year the exchange occurs. This form documents that the transaction met the 1031 requirements.
In summary, the basic 1031 exchange rules are: the exchange involves like-kind real estate, held for business/investment, with the same owner, using a QI, within the identification and exchange timelines, and replacing equal-or-greater value. Meeting all these rules lets you defer the capital gains tax.
What Is the 1031 Exchange Timeline?
The timeline for a 1031 exchange is very strict:
- Day 1 = Sale closing: The clock starts when you close (transfer title) on the relinquished property. The next calendar day is Day 1.
- Day 1–45 (Identification Period): Within 45 days of the sale closing, you must identify your replacement property(ies). Identification must be in writing, signed by you, and delivered to the QI or seller of the replacement property. You can identify up to three properties without regard to their market values (the “3-property rule”), or more than three if certain value tests are met (see below). Common practice: list three strong candidates.
- Day 46–180 (Exchange Period): You must close (buy) one of the identified properties by Day 180 after the sale of the old property. The 45-day identification and the 180-day exchange periods run concurrently. For example, if you identify a property exactly on Day 45, you then have 135 days remaining (Day 180) to close that purchase.
- No extensions: These deadlines are fixed by law. There are no extensions beyond 45 or 180 days for a typical exchange. (Only rarely, if the IRS issues a disaster relief waiver for specific areas and dates, might deadlines be extended. Barring that, plan on strict compliance.)
Identification rules: Besides naming up to three properties, there are alternative rules:
- 200% Rule: You may identify more than three properties if the total fair market value of all identified properties does not exceed 200% of the value of your relinquished property.
- 95% Rule: If you identify property exceeding the 200% limit, you may still complete the exchange if you end up acquiring at least 95% of the total value of all identified properties.
Practically, most investors stick to the simpler 3-property or 200% rules. Be sure to identify properties clearly (legal description or address) in writing by the deadline.
Key timeline points:
- Identify (in writing) by midnight of Day 45.
- Close on replacement by midnight of Day 180.
- Both days are calendar days, not business days.
If you fail to identify properly or miss the final closing deadline, the IRS will consider the sale a taxable sale, and you must recognize the capital gain in that tax year.
What Is “Boot” in a 1031 Exchange?
“Boot” is any value received by the exchanger that is not like-kind property. In other words, it’s the difference when you don’t fully reinvest the exchange proceeds. Boot triggers immediate tax on the amount received.
Common examples of boot:
- Cash boot: If you take any cash out of the exchange, that cash is taxable. For instance, if you sell a property for $1,250,000 and buy the new one for $1,100,000, you have $150,000 cash left over. That $150k is boot and is taxed as capital gain in the year of the exchange.
- Debt boot: If the mortgage or debt on the replacement property is lower than on the relinquished property, the debt relief is treated as boot. For example, if you sell a property with a $500,000 mortgage and buy a replacement with only a $400,000 mortgage, the $100,000 difference is like receiving cash; it is boot and is taxable.
- Property boot: If you receive non-like-kind property (e.g. personal property or an asset that doesn’t qualify) as part of the exchange, its value is boot.
To achieve 100% tax deferral, you must reinvest all proceeds and assume equal or greater debt on the new property. If you can’t, expect to recognize tax on the boot portion. It’s wise to plan ahead (for example, taking on extra financing or covering shortfalls with your own funds) to minimize or eliminate boot.
Who Can Do a 1031 Exchange?
Most U.S. taxpayers who hold real estate for business or investment can do a 1031 exchange. Eligible “exchangers” include:
- Individuals (sole proprietors)
- Partnerships (general or limited)
- Corporations (C-corps and S-corps)
- Limited Liability Companies (LLCs) taxed as above entities
- Trusts and estates
- Any other legal tax-paying entity.
The crucial point is consistency: the entity selling the old property must be the same that buys the new one. For example, if your property is owned by an LLC, the LLC must be the buyer of the replacement property as well.
What Types of Property Qualify for 1031 Exchange?
Only real property qualifies for a 1031 exchange under current law (as of 2025). Personal property (vehicles, equipment, furniture, patents, etc.) is not eligible due to the Tax Cuts and Jobs Act of 2017. Key property rules:
- Like-kind real estate: Most real estate in the U.S. is like-kind to other U.S. real estate. Examples: houses, rental condos, apartment buildings, commercial offices, retail centers, vacant land, ranches, industrial buildings, etc., as long as they’re investment or business properties.
- Within the U.S.: A U.S. property is not like-kind to one located outside the U.S., so the exchange properties must both be in the U.S. (or both abroad).
- Vacant land: Raw land (vacant) is like-kind to any improved real property (vacant land is like-kind to improved land, an office building to a warehouse, etc.), since the “nature or character” is still real property.
- Partnership interests: You cannot exchange a partnership or LLC interest for real estate (stock or partnership interests are not like-kind to real estate). You must exchange actual real estate asset holdings.
- Mixed-use properties: If a property has both personal and rental use (for example, a house you sometimes rent on Airbnb and sometimes live in), it can be tricky. To qualify, the property should be treated as held for business/investment. The IRS has safe-harbor rules for vacation homes (see below) to help establish the intent. If the personal use is too high, the property may not qualify, or only the portion attributable to business use qualifies.
- Partial interests: You generally need to exchange an entire ownership interest in property. Exchanging only part of a parcel for another whole parcel can be complicated, and partial interests (like fractional undivided shares) may not be allowed.
In sum, think of qualifying properties as any rental, commercial, or business real estate in the U.S., held for the purpose of earning income or as an investment. Primary residences and vacation homes used mostly for personal enjoyment do not qualify as exchange property unless they meet special use tests.
What Are the Benefits of a 1031 Exchange?
The main benefit of a 1031 exchange is tax deferral. By rolling the proceeds from a sale into a new property, you delay paying capital gains tax. This allows you to invest 100% of your equity (rather than paying potentially 15–20%+ in taxes) into a new property, accelerating your wealth growth. Key advantages include:
- Deferred Taxes, Greater Buying Power: You can swap up to a $10M gain (or more) without immediate tax, using that capital to acquire a bigger or better property. This can compound returns over time compared to paying tax and investing only the after-tax amount.
- Portfolio Rebalancing: A 1031 exchange lets you adjust your investments. For example, you might swap from older properties to new ones, diversify by acquiring multiple replacement properties, or consolidate many properties into one larger one. You can trade properties that are underperforming or in undesirable locations for ones that fit your strategy or market conditions.
- Changing Market or Investment Goals: It allows you to adapt to market shifts. If one market is declining, you can move your capital to a more promising area. Or you can change property type—say, selling a residential rental to invest in commercial real estate or vice versa, as long as it’s all business/investment use.
- Estate Planning Advantage: If you hold onto replacement properties until death, your heirs typically receive a step-up in basis to the fair market value at your death. This can eliminate the deferred gain entirely for federal tax purposes (estate tax rules apply separately). In effect, 1031 exchanges can be a tool to transfer wealth tax-efficiently to heirs.
- Deferred Depreciation Recapture: When you do a 1031 exchange of like-kind real estate, any accumulated depreciation on the property is also deferred (not recaptured at the time of exchange). This further defers what would otherwise be ordinary income tax. (Keep in mind that when you eventually sell without a 1031, you will recognize the total deferred gain and recaptured depreciation at that point.)
- Unlimited Repeats: There is no limit on how many times you can do a 1031 exchange. You can keep exchanging from one property to the next to continue deferring the gain.
In short, a 1031 tax-deferred exchange boosts your investment power and flexibility. Instead of shrinking your capital with taxes at every sale, you can reinvest all proceeds into new assets. Over years or generations, this can significantly grow your real estate wealth.
How Do You Report a 1031 Exchange?
At tax time, you must report the exchange on IRS Form 8824 (Like-Kind Exchanges) with your federal income tax return for the year in which you sold the relinquished property. Form 8824 requires details of the properties exchanged, dates, values, and the amount of gain deferred. If the exchange is done correctly, you will report that you deferred the gain and did not recognize any income (or only recognized boot, if any).
Even though you are deferring gain, you still file the form. It shows how much basis is carried over and ensures the IRS knows the transaction met 1031 rules. The replacement property’s basis is generally your old property’s basis, adjusted for any extra money put in or taken out.
Summary of Key Points
- A 1031 exchange lets real estate investors defer capital gains tax by swapping business/investment property for like-kind property.
- It is strictly for real estate in the U.S., held for investment or business use. No personal property or primary residences (unless converted).
- Deadlines are firm: Identify replacement(s) within 45 days, close within 180 days of the sale.
- Up to three properties can be identified (or more with valuation rules).
- The same taxpayer/entity must sell and buy. A qualified intermediary must handle the funds.
- The replacement property must be equal or greater value (or you pay tax on the difference, called “boot”).
- Vacation or Airbnb rentals can qualify if they meet IRS rental-use tests (minimal personal use).
- The advantage is tax deferral: you can reinvest all of your equity. The deferred tax becomes due when you finally sell without an exchange (unless a step-up at death occurs).
A 1031 exchange is a powerful strategy for real estate investors to grow and adapt their portfolios while deferring taxes. By following the IRS rules and timeline carefully, investors can smoothly exchange properties and continue building wealth. If you’re considering a 1031 exchange, make sure to work with experienced professionals (like a qualified intermediary and a tax advisor) to ensure all requirements are satisfied. Chalet can help you by connecting you with one of our vetted partners, completely for free. Click on the link here and discover our recommended partners.
If you are considering a 1031 exchange, your journey starts with picking the right market to pick for your next investment. Use our free Airbnb Market Dashboard to analyze market data, calculate rental income, track occupancy rates, and make data-driven short-term rental investment decisions.
