A 1031 exchange lets you sell business or investment real estate and defer the capital gains tax by reinvesting the proceeds into other like-kind real estate. It is deferral, not forgiveness: the deferred gain carries into the replacement property (though a basis step-up at death can erase it). You must identify replacements within 45 days, close within 180 days or by your return due date including extensions if earlier, and never touch the cash in between.

How does a 1031 exchange work?

Section 1031 of the tax code provides that no gain or loss is recognized when you exchange real property held for productive use in a trade or business, or for investment, solely for like-kind real property that you will also hold for business or investment use (IRC §1031(a)(1)). (Treas. Reg. 1.1031(k)-1(a); Form 8824 instructions). The key word is exchange. A sale followed by a separate purchase does not qualify, no matter how fast you move. The transaction must be structured as an exchange from the start, which is why almost every 1031 uses a qualified intermediary.

Three threshold facts:

1. Only real property qualifies. For 2018 and later years, section 1031 applies only to exchanges of real property. The old rules that covered equipment, vehicles, and other personal property are gone (Form 8824 instructions).

2. Investment or business use only. Property held primarily for sale (flips, dealer inventory) does not qualify, and neither does your personal residence (IRS Pub. 544).

3. **You report it. File Form 8824 with your tax return for the year you transferred the property; if you exchange California property for out-of-state replacement property, California also requires Form FTB 3840 for the year of the exchange and every later year until the California-source deferred gain is recognized.. It figures the gain deferred, any gain recognized, and your basis in the replacement property (Form 8824 instructions).

What counts as like-kind property?

Like-kind is broader than most people expect. Properties are of like kind if they are of the same nature or character, even if they differ in grade or quality. For real estate, improved and unimproved properties are generally like-kind to each other: you can exchange an apartment building for raw land, or a rental house for a commercial building (Form 8824 instructions).

Two limits: real property in the United States and real property outside the United States are not like-kind to each other, and partnership interests are generally not real property for this purpose (Form 8824 instructions).

What are the 45-day and 180-day deadlines?

These are the two dates that make or break the exchange. Both clock from the day you transfer the relinquished property:

• Identification period: 45 days. You must identify the replacement property in writing before midnight on the 45th day after the transfer (Treas. Reg. 1.1031(k)-1(b)(2)).

• Exchange period: 180 days. You must receive the replacement property before midnight on the earlier of the 180th day after the transfer or the due date (including extensions) of your tax return for the year of the transfer; if you sell late in the year, extend your return or your exchange period can be cut short of 180 days. (including extensions) for the year of the transfer (Treas. Reg. 1.1031(k)-1(b)(2); Form 8824 instructions).

Miss either deadline and the exchange fails. The transaction becomes a taxable sale. If a qualified intermediary holds the proceeds and releases them in the following tax year, you may be able to report the gain in the year you receive the cash under the installment method (Treas. Reg. §1.1031(k)-1(j)(2)); otherwise it is recognized in the year of the transfer.

How do you identify replacement property?

Identification must be in a written document, signed by you, sent before the deadline to the person obligated to transfer the replacement property (or another party to the exchange, like the intermediary), and the property must be unambiguously described: a legal description, street address, or distinguishable name (Treas. Reg. 1.1031(k)-1(c)).

You can identify more than one candidate property, within these limits:

If you identify more properties than these rules allow, you are treated as having identified nothing (Treas. Reg. 1.1031(k)-1(c)(4)).

What is a qualified intermediary, and why do you need one?

In a deferred exchange, the sale proceeds cannot pass through your hands. If you actually or constructively receive the cash, even briefly, the exchange collapses into a sale. The qualified intermediary (QI) solves this: you transfer the relinquished property to the QI, the QI holds the funds under an exchange agreement that restricts your access to them, and the QI acquires and transfers the replacement property to you. When the agreement properly limits your rights, the QI is not treated as your agent and you are not in constructive receipt of the funds (Treas. Reg. 1.1031(k)-1(g)(4); Form 8824 instructions).

Related parties and anyone who acted as your agent within the 2 years before the transfer (for example your attorney, accountant, or real estate broker) are disqualified from serving as your QI, though routine title, escrow, and exchange-only services do not count. Separately, if you exchange with a related party and either of you disposes of the exchanged property within 2 years, the deferred gain generally becomes taxable (IRC §1031(f)). (Form 8824 instructions).

What is boot, and when do you owe tax anyway?

Boot is anything you receive that is not like-kind property: cash, debt relief, or non-like-kind property. If you receive boot, gain is recognized up to the amount of boot received, but never more than your realized gain, and a loss is never recognized in a 1031 exchange. (Form 8824 instructions).

Common boot traps: taking cash out at closing, trading down to a cheaper property and pocketing the difference, or having debt paid off without replacing it with equal or greater debt or new cash on the replacement property. Any of these creates recognized gain.

How does a 1031 exchange interact with cost segregation and depreciation recapture?

This is the interaction investors miss. A 1031 exchange does not wipe out depreciation recapture. If you dispose of section 1245 or 1250 property in a like-kind exchange, a portion of your gain may still be reportable as ordinary income (IRS Pub. 544).

For section 1245 property, ordinary-income recapture in an exchange is limited to the gain recognized plus the fair market value of any non-section-1245 property you acquire (IRC §1245(b)(4)). Two cost-segregation traps follow: since 2018, 5- and 7-year personal property is generally not real property for §1031, so the value allocated to it is a taxable sale with its depreciation recaptured as ordinary income (unless it qualifies as real property under Treas. Reg. §1.1031(a)-3); and when section 1245 components are exchanged for a building (section 1250 property), the non-1245 property received can trigger full 1245 recapture even with no boot. 15-year land improvements are generally real property and, in a rental, usually section 1250 rather than section 1245 property. Under IRC §1245(b)(4), even with zero boot and zero gain recognized, section 1245 recapture can still be reportable as ordinary income when the property you receive includes non-section-1245 property (IRS Pub. 544).

Two practical consequences:

1. Cost segregation raises the stakes. Bigger accelerated depreciation means a bigger potential recapture amount sitting inside the exchange. Model it before you commit, not after.

2. Deferred gain shrinks future depreciation. Your basis in the replacement property is reduced by the gain you deferred, which means less depreciation to claim going forward. The exchange trades today's tax bill for a smaller depreciation shield tomorrow. That tradeoff is usually worth it, but run the numbers.

Illustrative example: a clean deferred exchange

Illustrative example: say you bought a rental property for $400,000 and claimed $100,000 of depreciation, leaving an adjusted basis of $300,000. You exchange it for a $600,000 replacement property through a qualified intermediary, with no boot.

• Gain realized: $600,000 minus $300,000 = $300,000.

• Gain recognized: $0 (no boot received).

• Gain deferred: $300,000.

• Basis in the replacement property: $300,000 (your old basis carries over, plus any gain recognized and any additional cash or new debt you put in, minus any cash or debt relief you received: $300,000 + $0 − $0).

Now say the same exchange includes $50,000 of cash back to you at closing, so you receive $550,000 of like-kind property plus $50,000 cash. That $50,000 is boot, so $50,000 of gain is recognized and taxed now, and only $250,000 is deferred. Because you claimed $100,000 of depreciation, the recognized gain is taxed as unrecaptured section 1250 gain at a maximum 25% rate (plus the 3.8% net investment income tax if it applies), not at the 20% capital gains rate. This is why exchangers avoid touching cash.

Pending review by Brian Thomas, EA. Updated September 25, 2026.

This article is free educational content, not tax advice for your specific situation. If you want a plan built around your actual numbers, that is what our paid tax planning engagements do.