1031 Exchange Rules & IRS Regulations

Navigate the complete framework of 1031 exchange regulations with confidence. From Section 1031 requirements to specific timing rules, we break down every regulation you need to know for a successful tax-deferred exchange.

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Quick Rule Reference

Days to Identify

180

Days to Close

Property Limit

95%

Reinvestment Rule

Understanding Section 1031 of the Tax Code

Section 1031 of the Internal Revenue Code provides one of the most powerful tax deferral strategies available to real estate investors. Established in 1921, this provision allows property owners to defer capital gains taxes when exchanging investment or business property for "like-kind" property.

The Legal Foundation

"No gain or loss shall be recognized on the exchange of real property held for productive use in a trade or business or for investment if such real property is exchanged solely for real property of like kind which is to be held either for productive use in a trade or business or for investment."

- IRC Section 1031(a)(1)

Key Principles

Tax Deferral, Not Tax Elimination

A 1031 exchange defers taxes rather than eliminating them. The deferred gain reduces your basis in the replacement property. When you eventually sell without doing another exchange, you'll pay taxes on the accumulated gain.

Investment Intent Required

Both the relinquished and replacement properties must be held for investment or productive use in a trade or business. Personal residences and property held primarily for sale do not qualify.

Equal or Greater Value Rule

To defer all taxes, you must reinvest the full net proceeds and acquire replacement property of equal or greater value. Any cash or debt relief received (boot) is taxable.

Properties That Qualify for 1031 Exchanges

✓ Qualifying Properties

Rental properties (residential or commercial)
Office buildings
Retail properties
Industrial properties
Raw land held for investment
Vacation rentals (with restrictions)
Tenant-in-common interests
Delaware Statutory Trusts (DSTs)

✗ Non-Qualifying Properties

Primary residences
Fix-and-flip properties
Inventory (developer property)
Stocks, bonds, or securities
Partnership interests
Foreign real estate (with exceptions)
Machinery and equipment

Important: "Like-Kind" Definition

For real estate, "like-kind" is interpreted very broadly. You can exchange any type of investment real estate for any other type. For example, you can exchange raw land for a rental property, or an office building for a retail center. The key is that both properties must be held for investment or business use.

Critical Timing Rules

45-Day Identification Period

You have exactly 45 calendar days from the date you close on your relinquished property to identify potential replacement properties. This deadline is absolute with no extensions, even if it falls on a weekend or holiday.

Identification Requirements:

• Must be in writing and signed
• Must clearly describe each property (address or legal description)
• Must be delivered to your Qualified Intermediary
• Cannot be revoked after the 45th day

180

180-Day Exchange Period

You must close on your replacement property within 180 calendar days of selling your relinquished property OR by your tax return due date (including extensions), whichever comes first.

Critical Points:

• No extensions available for any reason
• Must acquire property that was properly identified
• All closings must be complete within the period
• Tax filing deadline can shorten the 180-day period

Same-Day Exchanges

In a simultaneous exchange, both properties close on the same day. While this eliminates timing concerns, a Qualified Intermediary is still required to ensure the exchange qualifies under Section 1031.

Property Identification Rules

The IRS provides three ways to identify replacement properties. You must follow at least one of these rules to have a valid exchange:

Three-Property Rule

You may identify up to three properties regardless of their value. This is the most commonly used identification rule.

Example: You can identify three $10 million properties even if you're only selling a property for $500,000. You don't have to purchase all identified properties.

200%

200% Rule

You may identify any number of properties as long as their combined value doesn't exceed 200% of the value of your relinquished property.

Example: If you sell a property for $1 million, you can identify any number of properties as long as their total value doesn't exceed $2 million.

95%

95% Rule

You may identify any number of properties of any value, but you must acquire at least 95% of the total value of all properties identified.

Warning: This rule is risky because if you fail to acquire 95% of the identified properties, your entire exchange fails. Use with extreme caution.

Pro Tip: Always Have Backup Properties

Most investors use the three-property rule and identify three properties even if they only intend to purchase one. This provides backup options if your first choice falls through.

Essential Exchange Requirements

To Defer All Taxes

Equal or Greater Value

Purchase replacement property of equal or greater value than the net selling price of your relinquished property.

Reinvest All Proceeds

Use all net proceeds from the sale. Any cash received (boot) will be taxable.

Equal or Greater Debt

Replace all debt or use additional cash. Debt relief is treated as taxable boot.

Title Requirements

Same Taxpayer Rule

The same taxpayer who sells must buy. If John Doe sells, John Doe must buy (not John Doe LLC).

Disregarded Entities OK

Single-member LLCs are acceptable as they're disregarded for tax purposes.

Partnership Considerations

Partnerships can do exchanges, but special rules apply. Individual partners cannot exchange their partnership interests.

Critical: Boot Rules

"Boot" is any value received that's not like-kind property. This includes:

• Cash proceeds not reinvested
• Debt reduction (mortgage boot)
• Personal property received
• Non-qualifying property

All boot is taxable in the year of the exchange and cannot be deferred.

Prohibited Transactions & Related Party Rules

Receipt of Exchange Funds

The most critical rule: You cannot receive, control, or have constructive receipt of the exchange funds between the sale and purchase. This is why a Qualified Intermediary is essential.

Warning: Even touching the funds for one moment disqualifies the entire exchange. The funds must go directly from the closing to your QI.

Related Party Transactions

Exchanges with related parties are allowed but subject to special rules:

• 2-year holding requirement for both parties
• Family members include spouse, children, parents, siblings
• Entities you control are related parties
• Cannot be used to shift basis between parties

Disqualifying Events

These actions will disqualify your exchange:

✗ Using property as personal residence within 2 years
✗ Predetermined arrangement to sell to specific buyer
✗ Receiving exchange funds directly
✗ Violating the held for investment requirement

Qualified Intermediary Requirements

A Qualified Intermediary (QI), also known as an Exchange Accommodator, is essential for all delayed exchanges. The QI holds your funds and facilitates the exchange to ensure you never have actual or constructive receipt of the proceeds.

Who Can Serve as a QI

Any person or entity can serve as a QI except:

• You or your spouse
• Your attorney, accountant, or real estate agent
• Anyone who has provided services to you in the past 2 years
• Any entity in which you have more than 10% ownership
• Family members or related parties

QI Responsibilities

Documentation

• Prepare exchange agreements
• Document property identification
• Maintain exchange records
• Provide tax reporting documents

Fund Management

• Receive sale proceeds
• Hold funds in secure accounts
• Disburse for replacement property
• Maintain separate accounting

Choosing a QI: What to Look For

• Fidelity bond and insurance coverage
• Segregated client accounts
• Experience and track record
• Clear fee structure
• Strong financial backing
• Professional certifications

Reporting Requirements & Tax Compliance

Form 8824 - Like-Kind Exchanges

You must file Form 8824 with your tax return for the year of the exchange. This form reports:

• Description of properties exchanged
• Dates of identification and transfer
• Relationship of parties (if applicable)
• Value of like-kind and other property
• Adjusted basis calculations
• Realized and recognized gain

Basis Calculations

Your basis in the replacement property equals:

Basis of Relinquished Property

- Cash Received (Boot)

+ Cash Paid

+ Gain Recognized

- Loss Recognized

= Basis in Replacement Property

Record Keeping Requirements

Maintain these records indefinitely:

• Exchange agreement with QI
• Property identification notices
• Closing statements (HUD-1s)
• Form 8824 and tax returns

• Basis calculations
• Depreciation schedules
• All correspondence
• Evidence of investment intent

State Tax Considerations

While most states follow federal 1031 rules, some have additional requirements:

• California requires filing Form 3840
• Some states don't recognize out-of-state exchanges
• State depreciation recapture rules may differ
• Consult state-specific tax advisors

Common Mistakes to Avoid

Missing Deadlines

The 45 and 180-day deadlines are absolute. Missing them by even one day disqualifies your exchange.

Improper Identification

Vague descriptions or informal identifications don't count. Follow the rules precisely.

Taking Possession of Funds

Never let exchange funds touch your hands or accounts, even temporarily.

Changing Taxpayer

The same tax entity that sells must buy. Don't change from personal to LLC ownership.

Inadequate Investment Intent

Converting to personal use too quickly can retroactively disqualify your exchange.

Not Using a QI

Trying to do an exchange without a Qualified Intermediary will fail IRS scrutiny.

Navigate 1031 Rules with Confidence

Don't risk your exchange on technicalities. Our experts ensure every rule is followed perfectly, protecting your tax deferral and maximizing your investment potential.