What Is a 1031 Exchange?
A 1031 exchange, named after Section 1031 of the IRS tax code, allows real estate investors to defer paying capital gains taxes when they sell an investment property — as long as they reinvest the proceeds into another “like-kind” property.
In simpler terms, it’s a tax strategy for keeping your money working for you. Instead of paying the IRS after a profitable sale, you roll that profit into another investment and continue building equity.
This strategy is a cornerstone of long-term wealth building in commercial and investment real estate.
How a 1031 Exchange Works
Executing a successful 1031 exchange requires precision and timing. Here’s the basic process broken down step-by-step:
1. Sell Your Current Investment Property
You start by selling your existing investment property. The proceeds from that sale must go directly to a qualified intermediary (QI) — not into your own account. If you touch the money, you lose your 1031 eligibility.
2. Identify a Replacement Property
You have 45 days from the sale closing to identify potential replacement properties. The IRS allows you to list up to three properties (the “Three Property Rule”), but you must clearly identify them in writing to your intermediary.
3. Close on the Replacement Property
From the sale date of your original property, you have 180 days to close on one of the identified replacement properties. The intermediary transfers your funds at closing, completing the exchange.
4. File Proper Documentation
When tax season arrives, your accountant will help you file IRS Form 8824 to report the exchange and continue your tax deferral.
The Benefits of a 1031 Exchange
A 1031 exchange is one of the most powerful tax tools available to real estate investors.
✅ 1. Defer Capital Gains Taxes
You can defer up to 20%–30% of your taxable gain, allowing that money to keep growing through compound investment returns.
✅ 2. Grow Your Portfolio
Many investors use exchanges to trade into larger or more profitable properties — for example, exchanging a small apartment building for a retail center or industrial asset.
✅ 3. Diversify or Consolidate
A 1031 exchange isn’t limited to one-for-one swaps. You can exchange into multiple properties to diversify, or consolidate smaller holdings into one larger property for simpler management.
✅ 4. Step-Up in Basis
If you hold the property until death, your heirs may receive a step-up in cost basis, meaning deferred gains may be eliminated entirely.
