Real Estate Tax Calc
What is a 1031 exchange?
A 1031 exchange—also called a like-kind exchange or a tax-deferred exchange—is a transaction structure authorized by Section 1031 of the Internal Revenue Code that allows an investor to sell one investment or business property and buy another without recognizing gain in the year of the sale. The "exchange" name comes from the legal fiction that the investor is swapping one property for another, even though in practice the two transactions (sale and purchase) are separate events separated by weeks or months.
The tax benefit is substantial. When you sell an investment property you have held for years, you normally owe federal capital gains tax on the profit—at rates ranging from 0% to 20% for long-term gains, plus up to 25% on unrecaptured depreciation (§1250 gain), plus the 3.8% net investment income tax if your income exceeds threshold levels, plus state taxes. A properly executed 1031 exchange defers all of these taxes, keeping more capital in your hands for reinvestment.
Importantly, a 1031 exchange defers tax—it does not eliminate it. The deferred gain carries forward into the replacement property as a lower adjusted basis. When you eventually sell the replacement property without doing another 1031 exchange, the accumulated gain becomes taxable at that time. Many investors run a "swap till you drop" strategy, doing serial 1031 exchanges until death, when heirs receive a stepped-up basis under IRC §1014 that permanently eliminates the deferred gain.
Core requirements for a valid 1031 exchange
To qualify for tax-deferred treatment, an exchange must satisfy several core requirements set by IRC §1031 and Treasury Regulations.
Like-kind property: Both the relinquished (sold) property and the replacement (purchased) property must be real property held for investment or productive use in a trade or business. The "like-kind" standard for real property is broad—any US real property qualifies, regardless of property type. A single-family rental can exchange for a commercial building; raw land can exchange for an apartment complex. However, real property in the US and real property outside the US are not like-kind to each other.
Held for investment or business use: The property cannot be personal-use property (a primary residence, vacation home with significant personal use) or dealer inventory (property held primarily for sale). A property that was recently converted from personal use must have an adequate rental history before it qualifies.
Same taxpayer: The entity or individual that sells the relinquished property must be the same taxpayer that acquires the replacement property. A sale by an individual cannot be followed by a purchase by an LLC the individual controls—unless the LLC is a disregarded entity owned entirely by that same individual.
Qualified intermediary: The investor cannot take actual or constructive receipt of the sale proceeds at any point. A qualified intermediary (QI)—an independent third party—must hold the exchange funds between the sale and the purchase. If the investor receives or controls the money in any way, the exchange fails entirely.
Deadlines: From the date of sale of the relinquished property, the investor has exactly 45 calendar days to identify potential replacement properties in a written document delivered to the QI or another party. The investor then has 180 calendar days from the sale date (or the due date of the tax return for that year, whichever is earlier) to close on the replacement. Both deadlines are absolute—there are no extensions except for federally declared disasters.
The 1031 exchange process step by step
Step 1 — Engage a qualified intermediary before the sale closes. The QI agreement must be signed before the relinquished property closes. If you wait until after closing, you have already been in constructive receipt of the proceeds and the exchange cannot be done.
Step 2 — Sell the relinquished property. At closing, the title company or escrow officer sends all sale proceeds directly to the QI. The investor signs a direction letter instructing proceeds to go to the QI rather than to themselves.
Step 3 — Identify replacement property within 45 days. The investor must submit a written identification notice to the QI (or the seller of the replacement property) no later than midnight of the 45th day after the relinquished property closing. Identification must be specific—addresses or legal descriptions. The IRS permits identification under the 3-Property Rule (up to three properties of any value), the 200% Rule (any number of properties with total FMV not exceeding 200% of the relinquished property FMV), or the 95% Rule (any number of properties if you actually acquire 95% or more of the identified value).
Step 4 — Close on the replacement property within 180 days. The QI wires the exchange funds to the replacement property closing. Any remaining exchange funds not used are distributed to the investor and become taxable boot.
Step 5 — Report on Form 8824. The exchange is reported on IRS Form 8824 (Like-Kind Exchanges) filed with the tax return for the year in which the relinquished property was sold. The form calculates the deferred gain and the new basis in the replacement property.
Worked example: deferring $140,000 in gain
An investor purchased a single-family rental in 2015 for $300,000 (land: $60,000; building: $240,000). Over 11 years, MACRS depreciation reduced the building's adjusted basis by $96,000 ($240,000 ÷ 27.5 × 11 years). The investor sells in 2026 for $500,000.
Adjusted basis: $300,000 original cost minus $96,000 accumulated depreciation = $204,000.
Total gain: $500,000 sales price minus $204,000 adjusted basis = $296,000.
Tax tiers without a 1031 exchange (approximate, assuming 20% LT rate + 3.8% NIIT):
Tier 1 — Unrecaptured §1250 gain: $96,000 × 25% = $24,000. Tier 2 — §1231 gain: $200,000 × 23.8% (20% + 3.8%) = $47,600. Total approximate federal tax: $71,600. Plus state taxes.
With a 1031 exchange into a $600,000 replacement property: The investor uses the $500,000 from the QI plus $100,000 of new cash to buy the $600,000 replacement. No boot is received, so the entire $296,000 gain is deferred. The new basis in the replacement property = $600,000 purchase price minus $296,000 deferred gain = $304,000. This $304,000 adjusted basis is lower than the $600,000 purchase price, reflecting the carried-forward gain. Depreciation on the replacement property starts from the new $304,000 basis (less any land allocation), depreciating over the remaining recovery period.
Boot and partial exchanges
Boot is anything of value received in the exchange that is not like-kind real property. Boot is taxable up to the amount of the realized gain. Common forms of boot include:
Cash boot: Any exchange funds not reinvested in replacement property. If your relinquished property sold for $500,000 and you buy a replacement for $450,000, the $50,000 difference is cash boot—taxable up to the amount of gain.
Mortgage (debt) boot: If the mortgage on the replacement property is less than the mortgage on the relinquished property, the net debt relief is treated as boot. For example, if the relinquished property had a $200,000 mortgage and the replacement has only a $150,000 mortgage, the $50,000 net debt reduction is boot. Investors can offset debt boot by adding cash to the exchange or by financing the replacement more heavily.
A partial exchange occurs when some boot is received. The gain is recognized to the extent of boot received, and the remaining gain is deferred. The investor still benefits from deferring the portion of gain that was not covered by boot.
Common mistakes that kill 1031 exchanges
Not engaging the QI before closing: The most common and devastating mistake. Once you close without a QI in place, you have constructively received the proceeds and the exchange cannot be done retroactively.
Missing the 45-day identification deadline: The 45-day clock starts the moment the relinquished property closes—not the day you signed the contract. Many investors are surprised to find that the holiday season, travel, or deal complexity caused them to miss the deadline. Identify properties as early as possible.
Identifying too broadly under the 200% Rule: The 200% Rule allows you to identify more than three properties, but the total FMV of all identified properties cannot exceed 200% of the relinquished property's FMV. Investors who identify large portfolios of properties without tracking the math can inadvertently over-identify and disqualify the exchange.
Taking title in a different entity: If the LLC that sold the relinquished property is different from the entity that acquires the replacement, the exchange fails the same-taxpayer rule—even if the same individual owns both entities.
How to report a 1031 exchange to the IRS
A completed 1031 exchange is reported on Form 8824 (Like-Kind Exchanges), which is filed as part of the federal income tax return for the year in which the relinquished property was sold. The form requires information about both properties (descriptions, dates acquired, dates transferred/received, FMVs, adjusted bases), the exchange funds handled by the QI, any boot received, and the calculation of deferred gain and new basis. If the exchange spans two tax years—for example, the relinquished property closes in December and the replacement closes in February—a Form 8824 is filed in each year to report the incomplete exchange and then the completed exchange.
Frequently asked questions
What is a 1031 exchange in simple terms?
A 1031 exchange lets you sell an investment or business property and buy a replacement property of equal or greater value without paying capital gains tax in the year of sale. The tax is deferred—not eliminated—until you sell without exchanging. It is named after IRC §1031.
How long do you have to complete a 1031 exchange?
You have 45 calendar days from the sale of your relinquished property to identify potential replacement properties in writing, and 180 calendar days from that same sale to close on the replacement property. Both deadlines are strict with no IRS extensions except in declared federal disaster areas.
Do you need a qualified intermediary for a 1031 exchange?
Yes. The IRS requires that you never take constructive receipt of the sale proceeds. A qualified intermediary (QI) holds the funds between sale and purchase. If you receive the money yourself—even briefly—the exchange fails and the entire gain becomes taxable in the year of sale.
What types of property qualify for a 1031 exchange?
Since the Tax Cuts and Jobs Act of 2018, only real property held for investment or business use qualifies. Personal property (equipment, vehicles, artwork) no longer qualifies. Real property includes residential rentals, commercial buildings, raw land, and industrial facilities, as long as they are held for investment or productive use in a trade or business.
Can you do a 1031 exchange on a primary residence?
No. A primary residence does not qualify for a 1031 exchange because it is not held for investment or business use. However, a former primary residence that was converted to a rental property may qualify if it has been rented for an adequate period before the exchange. The IRS safe harbor under Rev. Proc. 2008-16 requires at least 24 months of rental use before the exchange.
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.