A 1031 exchange lets you sell investment or business real estate and defer capital gains and depreciation recapture taxes by reinvesting the proceeds into other "like-kind" real estate. You must identify replacement property within 45 days and close within 180 days, and a qualified intermediary must hold the cash. Since 2018, only real property qualifies.
This content is not tax or financial advice for you. Please talk with a CPA to find what's right for your situation.
How a 1031 exchange works
Normally, when you sell a rental property for a profit, you pay tax on the gain and on depreciation you've taken. A 1031 exchange, named after Section 1031 of the tax code, lets you defer that tax if you roll the value into new investment real estate.
Defer is the key word. The tax isn't erased. It carries into the new property through a lower tax basis.
The core rules
| Rule | What it means |
|---|---|
| Like-kind real property | Both properties must be real estate held for investment or business use. A rental can be exchanged for land, an office, or an apartment building. |
| Not personal use | Your primary home and property held mainly for resale (like flips) don't qualify. |
| 45-day identification | You must identify possible replacement properties in writing within 45 days of selling. |
| 180-day closing | You must close on the replacement within 180 days of the sale, or by your tax return due date (with extensions) if earlier. |
| Qualified intermediary | A third party must hold the sale proceeds. If you touch the money, the exchange fails. |
| Equal or greater value | To defer all the tax, buy property of equal or greater value and reinvest all the cash. |
| Same taxpayer | The person or entity that sells must be the one that buys. |
What is "boot"?
Boot is anything you receive that isn't like-kind property, such as leftover cash or debt relief that isn't replaced. Boot is taxable. A partial exchange still works, but you'll owe tax on the boot.
Identification rules for replacement property
Most investors use one of these:
- Three-property rule: identify up to three properties of any value
- 200% rule: identify any number of properties, as long as their total value is no more than 200% of what you sold
How 1031 exchanges and cost segregation work together
These two strategies are often paired, but there's an important wrinkle.
- The upside: A cost segregation study on your replacement property can create new depreciation, especially on any extra basis from added cash or debt.
- The wrinkle: Since 2018, only real property qualifies for a 1031 exchange. The 5- and 7-year personal property identified in a cost segregation study generally isn't like-kind real property. When you exchange a property that had a cost segregation study, the value allocated to those personal property items may trigger depreciation recapture as ordinary income, unless it's offset by similar property in the replacement.
This doesn't make the combination a bad idea. It just means you and your CPA should plan the sale allocation and the replacement purchase together.
Common 1031 mistakes
- Missing the 45- or 180-day deadlines (there are very few extensions)
- Receiving the sale proceeds directly instead of through a qualified intermediary
- Buying a cheaper replacement and creating taxable boot
- Changing the taxpayer, such as selling as an LLC and buying personally
- Forgetting about state tax rules
Frequently asked questions
Can I 1031 exchange into a short-term rental?
Can I do a 1031 exchange forever?
Does a 1031 exchange avoid depreciation recapture?
See what your property may qualify for
Run our 2-minute STR Qualification Quiz or model your Low / Mid / High cost segregation range.
Related guides
Depreciation Recapture: What It Is and How to Plan for It
Depreciation recapture taxes back some depreciation when you sell. Learn the 25% and ordinary rates, see an example, and explore ways to reduce or defer it.
Read guideCost Segregation for Real Estate Investors: Timing, Losses, and Strategy
Cost segregation only pays if you can use the deductions. Learn how passive loss rules, real estate professional status, and timing shape your strategy.
Read guideDepreciation for Real Estate Owners: The Basics
What is depreciation and how does it lower taxes on rental property? Learn the 27.5- and 39-year rules, what you can't depreciate, and common mistakes.
Read guideWhat Is a Cost Segregation Study? How It Works, Costs, and Savings
Learn what a cost segregation study is, how engineering reports reclassify 5-, 7-, and 15-year property for 100% bonus depreciation, and who benefits most.
Read guideThis content is not tax or financial advice for you. Please talk with a CPA to find what's right for your situation.