1031 Exchange Rules
A 1031 like-kind exchange — named for 26 U.S.C. § 1031 — lets real estate investors defer capital gains taxes indefinitely by rolling proceeds from a sold property into a replacement property of equal or greater value. Instead of paying 15–20% federal long-term capital gains tax plus depreciation recapture when you sell, you carry that tax obligation forward into the new property and keep the full sale proceeds working. The Tax Cuts and Jobs Act of 2017 limited 1031 exchanges to real property only, ending their use for equipment and other personal property. Done correctly with a qualified intermediary and tight deadline management (45 days to identify, 180 days to close), a 1031 exchange is one of the most powerful tax-deferral tools available to real estate investors — used repeatedly, it can defer gains across an entire investing career until death, when heirs receive a step-up in basis and the deferred gain disappears entirely.
Current Law (2026)
A 1031 like-kind exchange allows real estate investors to defer capital gains taxes by exchanging one investment property for another of equal or greater value.
| Parameter | Value |
|---|---|
| Property types | Real property only (TCJA eliminated personal property exchanges) |
| Identification period | 45 days from sale |
| Exchange period | 180 days from sale |
| Boot (cash received) | Taxable |
| Basis | Carries over from relinquished property |
| Depreciation recapture | Deferred (carries over) |
Legal Authority
- 26 U.S.C. § 1031 — Exchange of real property held for productive use or investment
How It Works
A 1031 exchange defers capital gains tax only on real property — any investment or business-use real estate qualifies, from apartment buildings to farmland to office buildings. The Tax Cuts and Jobs Act of 2017 stripped 1031 eligibility from equipment, vehicles, and other personal property; only real estate exchanges survive. Personal residences don't qualify — primary home gains are handled by the Home Sale Exclusion, and Qualified Opportunity Zones offer an alternative deferral mechanism for capital gains more broadly.
The exchange requires a qualified intermediary (QI), a neutral third party who holds the proceeds after the relinquished property closes. This is not optional: you cannot touch the sale proceeds, even briefly, without disqualifying the exchange. The QI must be engaged before the sale closes — not after. If the money ever passes through your account, the exchange fails entirely. The IRS does not license or regulate QIs, so vet carefully — QI fraud and insolvency have cost investors both their proceeds and a capital gains bill simultaneously.
Two hard deadlines govern every exchange. Within 45 days of closing the sale, you must identify replacement properties in writing to the QI. Three identification rules apply: the most-used is the "3-property rule" (up to three properties of any value); the "200% rule" allows any number of properties as long as their combined value doesn't exceed 200% of the relinquished property's value; and the "95% rule" allows any number of properties if you actually acquire at least 95% of their total identified value. Within 180 days of the original sale — not 180 days from identification — you must close on the replacement property. Neither deadline can be extended for market conditions, financing delays, or illness. Missing either makes the entire gain taxable in the year of the original sale.
To defer all tax, the replacement property must be equal or greater in both fair market value and mortgage debt. Any shortfall in value ("cash boot") or reduction in debt ("mortgage boot") is taxable in the year of the exchange. If you want to pull equity out of the transaction, the correct approach is to complete the exchange cleanly and then refinance the replacement property afterward — a cash-out refi is not a taxable event. The tax basis from the old property carries forward to the new one: the deferred gain remains alive, not forgiven, until the replacement property is eventually sold. If the investor dies holding the property, heirs receive a stepped-up basis equal to fair market value at death — permanently eliminating all deferred gains accumulated through serial exchanges.
How It Affects You
If you're selling an investment property with significant built-up gains: A 1031 exchange defers the entire capital gains tax — federal and state — that would otherwise be due at sale. On a property bought for $200,000 in 2005 and sold for $800,000 today, the $600,000 gain would generate approximately $90,000-$143,000 in federal capital gains tax (15-23.8% depending on income), plus state taxes in high-rate states. A 1031 into a replacement property of equal or greater value defers that entire bill, allowing the full $800,000 to compound in a new investment rather than $657,000 after paying taxes. The deferral is equivalent to an interest-free loan from the government. Serial 1031 exchanges — "swap till you drop" — combined with the step-up in basis at death can permanently eliminate these deferred gains.
If you're planning the exchange, watch the deadlines: The 45-day identification window (from closing the sale of the relinquished property) and 180-day acquisition window are absolute — there are no extensions, no exceptions for market conditions, and no IRS flexibility. You must select a qualified intermediary (QI) before the relinquished property closes; the QI holds the sale proceeds in escrow and you cannot touch the money. Selecting the QI after closing disqualifies the exchange. Identify your replacement property in writing to the QI within 45 days. If you don't close on an identified replacement property within 180 days of the sale, the entire gain is taxable in the year of sale — not spread over future years.
If you're considering receiving any cash from the sale: Any cash or other non-like-kind property you receive in the exchange ("boot") is immediately taxable — it doesn't qualify for deferral. A debt reduction also counts as taxable boot if you take on less debt on the replacement property than you had on the relinquished property. To defer all tax, the replacement property must be equal or greater in both value AND debt assumption. If you want some cash out of the transaction, the cleanest approach is to refinance the replacement property after the exchange is complete — the cash-out from a mortgage refinance is not a taxable event.
If you're in California or exchanging property into or out of California: California doesn't impose capital gains tax at the time of the exchange — but it requires filing Form FTB 3840 to track the deferred gain from California-sourced property. If you exchange a California property for one in another state, California retains a claim on the original gain — when the replacement property is eventually sold (even years later, even if you've moved out of California), California will attempt to collect capital gains tax on the original California-sourced appreciation. This "clawback" provision makes moving deferred gains out of California only partially effective. Consult a California tax attorney before exchanging a high-value California property for out-of-state replacement property.
State Variations
Most states conform to federal 1031 treatment. Notable exception:
- CA: Requires filing Form FTB 3840 to track 1031 exchanges. If a California property is exchanged for an out-of-state property, California "clawback" provisions may require tax on the original gain when the replacement property is sold.
Implementing Regulations
- 26 CFR Part 1 — Income tax regulations (section 1.1031(a)(3)-1: like-kind exchange identification and receipt rules; section 1.1031(k)-1: deferred exchanges; section 1.1031(h)-1: tax-exempt use property; section 1.1031(i)-6: involuntary conversions)
- 26 CFR 1.1031(a)-1 — Property held for productive use in trade or business or investment (defines qualifying property; like-kind property requirement post-TCJA limited to real property)
- 26 CFR 1.1031(a)-3 — Definition of real property (the post-TCJA definition limiting § 1031 to real estate; requires property to be classified as real property under state law or specific federal tests)
- 26 CFR 1.1031(b)-1 — Receipt of other property or money in tax-free exchange (boot rules: gain recognized to extent of money or non-like-kind property received)
Pending Legislation
- 1031 repeal/limits: Recurring proposals to repeal Section 1031 or cap the deferral amount ($500,000-$1,000,000). This is one of the most debated real estate tax provisions.
- Step-up in basis: Proposals to eliminate the step-up in basis at death would remove the "swap till you drop" strategy. See Step-Up in Basis.
Recent Developments
- 1031 exchanges remain available under current law: No federal cap or repeal of Section 1031 has been enacted as of April 6, 2026. The "swap till you drop" strategy — deferring gains through serial exchanges and potentially eliminating them with a stepped-up basis at death — remains available under current law.
- Step-up in basis remains under pressure: Proposals to eliminate the stepped-up basis at death (which permanently forgives deferred 1031 gains) have appeared in multiple budget proposals but have not passed. The combination of 1031 deferral + step-up at death remains the most powerful tax deferral mechanism available to real estate investors.
- Qualified intermediary fraud risk: SEC and IRS warnings have increased about Qualified Intermediary fraud — cases where QIs misappropriate exchange proceeds held in escrow. The IRS does not license or regulate QIs. If a QI fails while holding your funds, you lose both the proceeds AND owe capital gains tax. Use a QI with bonding, insurance, and segregated accounts. This is an underappreciated execution risk in any exchange.
- IRS clarification on reverse and improvement exchanges: The IRS has continued issuing guidance on complex exchange structures including reverse exchanges (buy replacement before selling relinquished) and improvement exchanges (using exchange proceeds to build on the replacement property). These structures are permitted under Revenue Procedure 2000-37 but must follow strict timing and title-holding rules.