A 1031 exchange is a swap of one investment property for another that allows capital gains tax to be deferred. The government is essentially letting you put off paying capital gains tax until you make a non-exchange sale sometime in the future. Instead of paying tax now, you get to use that money toward the purchase of another like-kind investment property — you end up paying only one tax, later, at a long-term capital gains rate.
A successful 1031 exchange gives you more buying power to keep building your real estate portfolio. Note that an estate attorney may have tactics beyond the scope of this article for passing along property in a way that eliminates capital gains tax after death — until then, the 1031 exchange is the main tool available.
A 1031 exchange is a swap of business or investment properties. If you rent out a house you own as an investment (subject to the rules below), that property qualifies. The concept behind it: when an investor exchanges a property for another of like-kind, they're merely continuing an ongoing investment rather than cashing out of one to obtain another.
The property exchange must be considered like-kind by the IRS for capital gains tax to be deferred. "Like-kind" is a bit misleading — you can sell one type of business property and buy certain other types in the same category, such as selling a vacation home you rent out and buying an apartment building as the replacement property.
A 1031 exchange (aka like-kind exchange) is a swap of one investment property for another. If the property you want to exchange meets requirements, you'll either have no tax or limited tax due at the time of the exchange. That limited tax is called Boot — see the glossary below.
In a reverse exchange, the replacement property is purchased before the sale of the relinquished property is completed. You must notify the qualified intermediary which property you intend to sell — in writing, signed, and delivered within the 45-day notification period. This tactic is best used in a very strong seller's market. In any other market, you need a much stronger understanding of the absorption rate and demand ratios in the area of your relinquished property to know how long it will realistically take to sell, and whether a reverse 1031 can succeed.
Unless you already have financing lined up with a lender willing to work with you around a 1031 exchange, you'll likely need to acquire the replacement property with cash through a qualified intermediary, using an Exchange Accommodation Titleholder (typically the QI itself). If you have an existing mortgage on the property you intend to sell, your lender will need to configure your new mortgage to match the dollar value of the existing mortgage or greater — a new mortgage for less than the existing one exposes the reduced portion to capital gains tax, and you'll be carrying two mortgages until the relinquished property sells.
After the replacement property is purchased, you then have 45 days to identify the relinquished property, and a total of 180 days (which includes that 45-day identification period) to close on its sale: 45 days + 135 days = 180 days.
Typically you'll need a qualified intermediary — an arms-length middleman who holds the proceeds from the sale of your property, then uses those funds to "buy" the replacement property for you. This three-party structure is the swap exchange.
45-day rule: after your property sells, the intermediary receives the funds — not you. If you receive the cash directly, the exchange is disallowed and you owe capital gains tax as though no 1031 was attempted. Within 45 days of the sale, you must identify up to 3 potential replacement properties and notify the intermediary in writing.
180-day rule: you must close on the replacement property within 180 days of the sale of your relinquished property. Miss the deadline and the exchange is disallowed.
Timelines run concurrently (at the same time): the 45-day identification period and the 180-day acquisition period both start counting from the day the sale of your property closes. If you designate a replacement property on day 45, you have 135 days left to close on it (45 + 135 = 180 days).
If you rent out your vacation house, follow the personal-usage timeframes, and treat it like a business (pay taxes on the rent, keep records, etc.), you can qualify it as an investment property for 1031 purposes. You must rent the house to another person at a fair market price for 14 days or more per year. Your personal use of the house cannot exceed 14 days, or 10% of the number of days it's rented at fair market price during the 12-month period — whichever is greater.
1031 exchanges apply to real property held for investment purposes. A vacation home used purely personally, without being rented out, will likely be disallowed by the IRS for a 1031 exchange.
Per the IRS: real property includes land and generally anything permanently built on or attached to land. Real property also includes property characterized as real property under applicable state or local law. Certain intangible property, such as leaseholds or easements, also qualifies as real property under Section 1031. Property not eligible for like-kind treatment prior to enactment of the TCJA remains ineligible.
IRS: final regulations on like-kind exchanges of real property
You must notify the IRS of the 1031 exchange by submitting Form 8824 with your tax return for the year the exchange occurs. Current Form 8824 on IRS.gov.
| Term | Meaning |
|---|---|
| 3 Property Rule | You can identify up to 3 replacement properties within the 45-day identification period. |
| 200% Rule | You can identify as many replacement properties as you choose, as long as their combined fair market value stays within 200% of the fair market value of your relinquished property. |
| 95% Rule | You can identify replacement properties worth more than 200% of the relinquished property's value, but only if you then acquire 95% of the identified properties' combined fair market value. Fall short and the exchange is disallowed. |
| 45-Day Rule | You have 45 days to identify the replacement property or properties, in writing, signed, and delivered to a key person in the exchange (typically the qualified intermediary, escrow agent, or title company) — not just your real estate agent. Include the street address if assigned, parcel number, legal description, and any other identifying detail. |
| 180-Day Rule | From the date your relinquished property closes, you have 180 days to complete all aspects of the 1031 exchange. |
| Boot | Anything in the exchange that is not deferred, including reduction of mortgage debt. Boot occurs if any portion of sale proceeds isn't reinvested into the replacement property, or if your replacement property carries a lower mortgage than the one you paid off (mortgage boot). Example: sell for $500,000 with $200,000 remaining mortgage, leaving $300,000 in equity — to fully avoid capital gains, the replacement property should be $500,000 made up of an equal mix of that equity and debt. Any cash you don't reinvest, or any reduction in mortgage debt, is taxable — though you can offset a mortgage reduction by bringing in new funds. |
| Code 1031 | Under Internal Revenue Code Section 1031, capital gains tax is deferred and no gain or loss is recognized in the transaction. |
| Drop and Swap | A method used when one partner or partners in an LLC want to cash out while other members want to continue holding the property. |
| Exchange Accommodation Titleholder (EAT) | An intermediary who holds title to the relinquished or purchased property (in a reverse 1031) while the other half of the transaction is finalized. Neither you nor anyone disqualified from receiving notification of your selected replacement properties can act as an EAT. |
| Exchangor | You — though when you enter an agreement with a qualified intermediary, the QI assumes your role in the transaction so no 1031 rule is violated. |
| Like-Kind | Real estate allows a wide range of like-kind pairings — a house for a house, or three houses for a multi-family property, for example. Confirm specifics with your qualified intermediary. |
| Parked Property | The relinquished or replacement property held by the Exchange Accommodation Titleholder, usually in an LLC, under the terms of a Qualified Exchange Accommodation Arrangement (QEAA). |
| Qualified Intermediary (QI) | An independent third party who, by agreement, sells your property, collects the sale funds, and uses them to acquire a replacement property for you. Direct swaps are possible but rare, which is why a QI is typically needed. |
| Qualified Exchange Accommodation Arrangement (QEAA) | The agreement under which a third party holds title to the relinquished or replacement property. |
| Reverse Exchange | The replacement property is purchased before the sale of the relinquished property is completed. |
| Relinquished Property | The property you are selling or have sold. |
| Replacement Property | The property you are buying or have purchased. |
| Safe Harbor Period | The 45-day identification period and 180-day closing period, running concurrently from the day the EAT closes on the replacement property. |
| Starker Exchange | Another name for the 1031 exchange, after the case T. J. Starker, Appellant, v. United States of America, Appellee — read it on Google Scholar. |
| Swap Exchange | Typically a three-party exchange involving a qualified intermediary, seller, and buyer. A swap exchange without a QI is possible if you can schedule a simultaneous closing of the relinquished and replacement properties — confirm with your accountant that they're familiar with Section 1031 before attempting this on your own. |
Throughout Florida, with a concentration in Sarasota, Charlotte, DeSoto, Hillsborough, Polk, and Pinellas counties, plus parts of Lee, Pasco, and Manatee counties — North Port, Englewood, Punta Gorda, Valrico, Brandon, Lithia, FishHawk, and wherever clients call in from. Personalized referral service is also available statewide, including a price opinion before the referral is made so you have that in hand alongside whichever broker accepts it.
Disclaimer: the author of this article is a Florida real estate broker, not an attorney or accountant. It's intended as a starting point for your own research into the 1031 exchange, and while believed accurate, it isn't guaranteed. Consult your own legal and tax professionals for advice specific to your situation before relying on any of this to make a decision.