What it is
TL;DRSection 1031 lets you sell business or investment real estate and defer 100% of the capital gain and depreciation recapture, provided you reinvest the proceeds into 'like-kind' real property through a qualified intermediary within strict deadlines. Do it repeatedly and the deferred gain can be wiped out entirely at death via the step-up in basis.
Since the 2017 tax law, §1031 applies only to real property, no more exchanges of equipment, vehicles, or collectibles. But for real estate it remains one of the most powerful wealth-compounding tools available, because the deferred tax stays invested and keeps earning.
The strategy's quiet superpower is 'swap till you drop': exchange repeatedly during life, never recognizing gain, then let your heirs inherit the final property with a stepped-up basis that erases the deferred gain permanently.
Who it's for
Owners of appreciated investment or business-use real estate who want to reposition (bigger, better-located, lower-management) without losing a third of their equity to tax at every move.
- ✓Landlords trading up from smaller to larger or better properties
- ✓Owners consolidating several properties into one (or splitting one into several)
- ✓Investors moving from management-intensive rentals into passive DSTs
- ✓Anyone with large deferred depreciation recapture exposure on a sale
- ×Owners who want to cash out and spend the proceeds (defeats the purpose)
- ×Flippers and dealers (property held primarily for resale doesn't qualify)
- ×Sellers of a primary residence (use §121 exclusion instead)
How it works
1. Engage a qualified intermediary before closing
You cannot touch the sale proceeds. A qualified intermediary (QI) must hold the funds between the sale of the old property and purchase of the new one. Set this up before the relinquished property closes, after closing is too late.
2. Identify replacement property within 45 days
From the day the relinquished property closes, you have 45 calendar days to identify replacement candidates in writing, typically up to three properties (or more under the 200% / 95% rules).
This deadline is absolute. There are no extensions for weekends, holidays, or bad luck.
3. Close on the replacement within 180 days
You must acquire the replacement property within 180 days of the original sale (or your tax-return due date, if earlier). To fully defer, buy equal or greater value and reinvest all the equity; any cash or debt relief you pocket ('boot') is taxable.
Trade equal or up, in both price and debt. Receiving cash, reducing your mortgage, or buying down in value all create taxable boot, the most common way a well-intentioned exchange ends up partly taxable.
4. Carry over basis and track it
The replacement property takes the old property's adjusted basis plus any new money added. Depreciation continues on the carried-over basis, so meticulous basis tracking across exchanges is essential.
A worked example
Diane owns a fourplex in Cedar City she bought for $300,000 (now depreciated to a $210,000 basis) and can sell for $700,000. She wants to move into a $1.1M retail strip with less day-to-day management. She uses a 1031 exchange instead of an outright sale.
| Taxable sale, then rebuy | §1031 exchange | |
|---|---|---|
| Capital gain + recapture exposed | $490,000 | $0 (deferred) |
| Federal tax (LTCG + 25% recapture) | ≈ $108,000 | $0 |
| Utah state tax (≈4.65%) | ≈ $22,800 | $0 |
| Equity available to reinvest | ≈ $569,000 | $700,000 |
| Tax deferred at this step | ≈ $131,000 |
Diane keeps roughly $131,000 of tax working for her, buying a $1.1M property on the full untaxed equity. If she keeps exchanging and holds the final property until death, her heirs inherit it with a stepped-up basis and the deferred gain disappears.
Limits and risks
The deadlines are unforgiving: 45 days to identify, 180 days to close, no exceptions. A failed identification turns the whole transaction into a taxable sale.
Boot is the silent killer, take cash out, reduce debt, or buy down in value and that portion becomes immediately taxable, often surprising owners who thought they had a 'full' exchange.
There has been recurring political pressure to cap or repeal §1031. The tool is intact today but shouldn't be assumed permanent for very long horizons.
The IRS scrutinizes whether the property was genuinely 'held for investment' (not flipped), whether the QI was truly independent, and whether the deadlines were met. Keep the exchange agreement, identification notice (date-stamped), and closing statements; these documents win or lose the position.
IRS reference
- IRC §1031Allows deferral of gain on the exchange of real property held for productive use or investment.
- Treas. Reg. §1.1031(k)-1The deferred (Starker) exchange rules, including the 45- and 180-day deadlines.
- Rev. Proc. 2000-37Safe harbor for reverse exchanges (buy the replacement before selling the relinquished property).