A 1031 Exchange is one of the most powerful tax-deferral strategies in real estate. Whether you’re a new investor or a seasoned pro, understanding how to legally defer capital gains taxes can help you build wealth faster and scale your portfolio.
Below, I answer the most frequently asked questions about 1031 Exchanges, so you can maximize your investment while staying compliant with IRS regulations.
What is a 1031 Exchange?
A 1031 Exchange (named after IRS Section 1031) allows investors to sell an investment property and reinvest the proceeds into another like-kind property without paying capital gains tax. Instead of handing over money to the IRS, you defer the tax and use that money to grow your portfolio.
Who Qualifies for a 1031 Exchange?
To qualify for a 1031 Exchange, you must be an investor or business owner. Eligible entities include:
- Individuals
- LLCs
- Corporations (S-Corp and C-Corp)
- Partnerships
- Trusts
The key requirement is that the property must be held for investment or business purposes, not for personal use.
What Types of Properties Can Be Exchanged?
The IRS defines like-kind properties as those used for investment or business purposes. This means you can exchange almost any type of real estate for another.
- Multifamily properties
- Commercial properties
- Retail centers
- Industrial buildings
- Vacant land
- Office buildings
Primary residences do not qualify.
How Does a 1031 Exchange Work?
A 1031 Exchange follows strict IRS rules:
- Sell your investment property
- Proceeds go to a Qualified Intermediary (QI), not you
- Identify up to three replacement properties within 45 days
- Close on a new property within 180 days
- Defer capital gains taxes and reinvest 100 percent of the proceeds
Failing to meet these deadlines will disqualify your exchange, meaning you will owe capital gains tax on the sale.
Can You Do a 1031 Exchange on a Primary Residence?
No. A 1031 Exchange is only for investment or business properties. However, you may be able to convert a rental property into a primary residence after holding it for investment purposes. The IRS Section 121 Exclusion may allow for partial tax benefits.
Can You 1031 Exchange a Second Home or Vacation Rental?
Possibly. To qualify, the property must be used primarily as an investment. The IRS requires:
- The property must be rented out for at least 14 days per year
- Personal use must be limited
If you primarily use the property for personal vacations, it does not qualify for a 1031 Exchange.
What Are the Deadlines for a 1031 Exchange?
The IRS sets two strict deadlines:
- 45 Days: Identify your replacement property within 45 days of selling your old one
- 180 Days: Close on the new property within 180 days of selling your original property
Missing these deadlines means losing your tax deferral.
What is a Reverse 1031 Exchange?
A Reverse 1031 Exchange lets you buy a new property first before selling the old one. This is useful in competitive markets where you need to secure an investment quickly.
However, you must pay for the new property upfront before selling your current one. Many investors use bridge loans to fund the purchase.
Can You Do a 1031 Exchange Into Multiple Properties?
Yes. The IRS allows you to exchange one property for multiple properties, but there are rules:
- Three Property Rule: You can identify up to three properties, regardless of value
- 200 Percent Rule: You can identify more than three properties, as long as the total value does not exceed 200 percent of the sold property
- 95 Percent Rule: You must acquire at least 95 percent of the total identified properties
What is Boot in a 1031 Exchange?
“Boot” is any cash or non-like-kind property received during the exchange. Examples include:
- Taking cash out at closing
- Debt reduction (buying a cheaper property)
- Receiving personal property in the exchange
If you receive boot, you will owe capital gains tax on that portion of the transaction.
How Much Does a 1031 Exchange Cost?
Costs vary, but a basic 1031 Exchange typically costs $1,000 to $3,000 in Qualified Intermediary fees. A Reverse 1031 Exchange is more complex and can range from $5,000 to $7,500.
What Happens if a 1031 Exchange Fails?
If you miss deadlines or do not reinvest all funds, your exchange will fail. That means:
- You owe full capital gains tax
- You may also owe depreciation recapture tax
To avoid this, work with a Qualified Intermediary and stick to IRS rules.
Can You Use a 1031 Exchange to Pay Off a Mortgage?
No. The IRS requires that 100 percent of the proceeds from your sold property must be reinvested into new real estate. Paying off a mortgage with exchange proceeds will disqualify the exchange and trigger taxes.
How to Report a 1031 Exchange on Your Tax Return?
You must file IRS Form 8824 with your annual tax return. This form reports:
- The properties involved
- Sale and purchase prices
- Any boot received
- Deferred capital gains
Consult a tax professional to ensure compliance.
Will 1031 Exchanges Be Eliminated in 2024 or 2025?
While proposed tax changes have targeted 1031 Exchanges, they remain legal in 2024. However, future tax reform could impact this strategy.
Final Thoughts
A 1031 Exchange is one of the most powerful tax strategies in real estate investing. It allows you to defer taxes, scale your portfolio, and build long-term wealth.
If you are planning to sell an investment property, consider a 1031 Exchange to avoid a massive tax bill and keep your money working for you.
Want to dive deeper into 1031 strategies? Join my Multifamily Bootcamp and learn from top investors who have mastered tax-deferral strategies to build generational wealth.
