A 1031 exchange lets you sell real estate and buy replacement property without paying capital gains tax on the sale, as long as you follow specific timing and property rules.

The name comes from Section 1031 of the Internal Revenue Code. When you sell investment property or business real estate at a profit, you normally owe federal tax on that gain. A 1031 exchange defers that tax by requiring you to reinvest the proceeds into similar property within strict important date. The tax liability doesn't disappear—it transfers to the new property and becomes due only when you eventually sell without doing another exchange.

The exchange must involve real property: land, rental houses, commercial buildings, or apartment complexes. You cannot exchange a primary residence, a vacation home you sometimes rent, or property held primarily for resale. The replacement property must be of equal or greater value than what you sold, and you must identify it within 45 days of closing your sale and complete the purchase within 180 days.

Key Takeaways

  • You have 45 days from closing to identify replacement property and 180 days total to close the purchase, or the tax deferral is lost.
  • The replacement property must be real estate held for investment or business use, and must equal or exceed the value of the property you sold.
  • A may have access to intermediary must hold the sale proceeds—you cannot touch the money or the exchange fails and taxes become due when ready.
  • The tax is deferred, not erased; you owe it when you eventually sell the replacement property unless you do another exchange.
  • State and local taxes may still explore even if federal tax is deferred, depending on where the properties are located.

How the timing and intermediary requirement work

The 45-day identification window starts the day your sale closes. You must provide written notice to a may have access to intermediary—a third party licensed to hold the funds—naming the replacement property or properties you intend to buy. You can identify up to three properties of any value, or more than three if their combined value does not exceed 200 percent of the sale price. This is called the "three-property rule" or the "200 percent rule," and you must choose one before the 45 days end.

The 180-day clock also starts on closing day. You must close on the replacement property by day 180, or the entire exchange fails. Weekends and federal holidays count toward both important date. If day 45 or day 180 falls on a weekend or holiday, the important date moves to the next business day. Many investors build in extra time by closing their sale early in the year, giving themselves more calendar days to find and close on replacement property.

You cannot hold the sale proceeds yourself. The may have access to intermediary receives the money from your buyer and holds it in escrow until you close on the replacement property. If you take possession of the funds—even for a day, even if you plan to reinvest it—the IRS treats the exchange as failed and you owe all deferred taxes when ready, plus penalties.

What counts as like-kind property

The IRS definition of "like-kind" for real estate is broad: almost any real property held for investment or business use qualifies as like-kind to any other. You can exchange an apartment building for raw land, a commercial office for a rental house, or a strip mall for a farm. The properties do not need to be the same type, in the same state, or generate the same income.

What does not may have access to: a primary residence, a vacation home (even if you rent it part of the year), property held for resale or development, a business you operate from the property, or personal property like equipment or vehicles. If you own a rental house and want to exchange it, the replacement must also be held as a rental investment, not converted to a personal residence.

The replacement property must be equal to or greater in value than the property you sold. If you sell a $500,000 rental house, you must reinvest at least $500,000 in replacement property. If you reinvest less, the difference is taxed as a gain in the year of the exchange. You can reinvest more than the sale price, and many investors do to defer tax on a larger amount.

The tax deferral versus elimination

A 1031 exchange defers federal capital gains tax, but does not erase it. When you eventually sell the replacement property without doing another exchange, you owe tax on the original gain plus any additional appreciation on the replacement property. Some investors chain multiple exchanges together over decades, continuously deferring tax until they die—at which point their heirs receive a "stepped-up basis" and the accumulated tax liability disappears.

State and local taxes are not deferred by a 1031 exchange. Depending on where your properties are located, you may owe state capital gains tax, state income tax on the gain, or local transfer taxes. Some states have their own exchange rules that differ from federal rules, so you should verify the rules in any state where you own property.

The tax deferral is valuable only if you actually owe tax on the sale. If you have a loss on the property or your gain is small, the complexity and cost of an exchange may not be worth it. A may have access to tax professional or CPA can calculate whether an exchange makes financial sense for your situation.

Costs and who handles the exchange

A may have access to intermediary charges a fee to hold the funds and manage the exchange paperwork, typically $500 to $2,000 depending on the complexity and the intermediary's rates. You will also need a real estate attorney or tax professional to review the exchange structure and may support compliance, which may cost $1,000 to $3,000. These costs reduce the net proceeds from your sale but are often much smaller than the tax you defer.

You find and negotiate the replacement property yourself—the intermediary does not search for it or represent you in the purchase. You work with your own real estate agent, attorney, and lender just as you would in any purchase. The only difference is that the intermediary receives the sale proceeds and releases them to close on your behalf.

Some investors use a 1031 exchange facilitator or accommodation company, which is a type of may have access to intermediary. These companies specialize in exchanges and can provide guidance on timing, property identification, and documentation. They are not the same as a real estate agent or investment advisor, and they do not give tax or legal information—that comes from your CPA or attorney.

Common reasons the exchange fails

The most common failure is missing the important date. If you do not identify replacement property by day 45, or do not close by day 180, the exchange is void and taxes are due. Extensions are not available, even if you have a good reason. Some investors miss the important date because they cannot find suitable property in time, or because financing falls through on the replacement purchase.

Another failure point is touching the sale proceeds. If you instruct the intermediary to wire funds to you, or if you take a loan against the escrowed funds, the IRS may disqualify the exchange. Even a brief period in your possession can trigger this. Always confirm with your intermediary and tax advisor before any transaction involving the sale proceeds.

A third common issue is buying replacement property that does not meet the like-kind test. If you buy a primary residence, or property held for resale, or a business you will operate, the exchange fails. You must document that the replacement property is held for investment or business use from the moment you close.

When a 1031 exchange makes financial sense

An exchange is most valuable when you have a large gain on the property and are in a high tax bracket. If you sell a rental house for $200,000 more than you paid, and your combined federal and state tax rate is 30 percent, you would owe $60,000 in tax. Deferring that tax by exchanging into another property preserves that $60,000 to invest in the replacement property, which can compound over time.

An exchange also makes sense if you want to consolidate or diversify your real estate holdings. You might sell three small rental properties and buy one larger apartment complex, or sell a commercial building and buy multiple single-family rentals. The exchange allows you to restructure your portfolio without triggering a large tax bill.

An exchange does not make sense if you have a small gain, a loss, or if you are selling to exit real estate investing altogether. The complexity and cost are not worth deferring a small tax. Similarly, if you need access to the sale proceeds to pay off debt or fund other plans, an exchange locks the money into replacement property for 180 days and beyond.

Frequently Asked Questions

Can I do a 1031 exchange if I own the property with a partner or as a corporation?

Yes, but the entity that sells must be the same entity that buys. If you own the property as a partnership, the partnership must do the exchange. If you own it as an LLC, the LLC must do the exchange. You cannot sell as a partnership and buy as an individual, or vice versa, or the exchange fails.

What happens if I identify three properties but only close on one?

That is fine. You can identify multiple properties within the rules and close on any one of them. Once you close on a replacement property, you have satisfied the exchange requirement. Any properties you identified but did not purchase are straightforward not part of the exchange.

Can I use a 1031 exchange to buy a vacation home I will rent out part of the year?

No. A vacation home held for personal use does not may have access to as like-kind property, even if you rent it out occasionally. The property must be held primarily for investment or business use from the start. If you buy it intending to use it personally, the exchange fails.

Do I have to reinvest the entire sale price, or can I keep some of the money?

You can keep money, but any amount you do not reinvest is taxed as a gain in the year of the exchange. If you sell for $500,000 and reinvest only $400,000, the $100,000 difference is taxed at your capital gains rate. To defer all tax, you must reinvest at least the full sale price.

What if the replacement property I want to buy is not available until after the 180-day window?

The exchange fails and you owe tax on the gain. There is no extension for any reason. If you cannot close within 180 days, you must pay the tax. Some investors close on a temporary replacement property within the window and then exchange it later, but this requires careful planning with a tax professional.