Seven IRS rules govern every 1031 exchange, and each is pass or fail. Miss one, even by a day or a technicality, and the exchange collapses and the tax comes due. Knowing all seven before you start is the real protection.
Break one rule in a 1031 exchange and the whole thing unwinds. The proceeds get released to you, and the capital gains tax you were deferring comes due in full. There is no partial credit and no do-over.
A 1031 exchange lets you sell an investment property and roll the proceeds into another without paying that tax now, but only if you clear seven separate requirements. Each one is pass or fail.
Rule 1: The property must be held for business or investment
Section 1031 covers real property held for productive use in a trade or business or for investment, and the IRS judges you on how you actually used the property, not on what you say you intended.
That takes in a wide range: rental properties from single-family houses to commercial buildings, farmland, raw land held for appreciation, and industrial space. It leaves out your primary residence and anything bought to resell - fix-and-flip projects, development lots, inventory. Those are dealer properties, and Section 1031 does not reach them.
The classic misstep is buying a property, renovating it, and selling six months later with no rental activity on the books. The IRS reads that pattern as dealing, not investing. A more conservative footing is to hold for at least 12 months with rental income reported on Schedule E; two full tax years is harder to challenge in an audit. Mixed use - part personal, part rental - is worth running past a tax advisor before you sell.
Rule 2: Like-kind means real property for real property
Any U.S. real property held for business or investment is like-kind to any other U.S. real property held for business or investment. What matters is the nature of the asset, not its type, grade, or quality. A single-family rental and a 50-unit apartment building are like-kind. So are a strip mall and farmland, or a warehouse and an office building.
The limits are narrow but firm. U.S. property does not exchange for foreign property. Personal property of any kind is out - since the 2017 Tax Cuts and Jobs Act, only real property qualifies. A rental swapped for a partnership interest does not work either, though interests in certain real-property-holding entities can with careful structuring.
The usual error is assuming like-kind means the same type of property, or attempting a cross-border swap. Confirm both sides are U.S. real property held for investment or business, and the requirement is broadly met.
Rule 3: A qualified intermediary must hold the funds
In a deferred exchange, a qualified intermediary (QI) - an independent firm that holds your sale proceeds between the sale and the purchase - stands between you and the money. The point is to prevent constructive receipt: the moment those funds are within your reach, the exchange is dead.
The QI has to be genuinely independent. It cannot be anyone who has acted as your agent, employee, attorney, accountant, or broker within the two years before the exchange. The regulations call these disqualified persons. (Routine legal work unrelated to the exchange is an exception, but a dedicated QI firm is the cleanest route.)
Where people fail is timing. If the sale closes before the QI agreement is signed, constructive receipt has already happened and nothing can undo it. Engaging the QI and signing the exchange agreement before closing, then confirming the QI's wire instructions with the title company so proceeds go straight to the QI, is what keeps that from happening.
Rule 4: Identify replacement property within 45 calendar days
By midnight on Day 45 you have to hand your QI a written, signed document naming each property you might buy, described clearly enough to be unambiguous - a street address or legal description does the job.
There are three ways to identify, and you pick one:
Rule | What you can identify | Constraint |
|---|---|---|
3-Property Rule | Up to 3 properties | No value limit |
200% Rule | Any number of properties | Combined FMV cannot exceed 200% of sale price |
95% Rule | Any number at any value | Must acquire at least 95% of total identified value |
The 3-Property Rule covers most exchanges. The 95% Rule is almost never practical.
The trap is treating those 45 days as time to go shopping rather than time to confirm a decision you have mostly made. People wait until Day 44 and then run into a bounced email, a failed fax, or a courier that never arrives. Lining up two or three strong candidates before the sale closes, and delivering the identification by Day 40, leaves room for things to go wrong.
Rule 5: Close on the replacement property within 180 calendar days
The replacement has to be closed and recorded by Day 180, or by the due date of your tax return including extensions, whichever comes first.
That "whichever comes first" is where the calendar can bite. Sell in late October, November, or December, and an April 15 return due date arrives before Day 180 does, quietly shortening your window. Filing Form 4868 for an extension restores the full 180 days, and it costs nothing.
Being under contract or in escrow on Day 180 is not enough - the deed has to be recorded. Aiming to close by Day 160 leaves a buffer for the delays that tend to surface at the end.
Rule 6: Reinvest all the equity and replace all the debt for full deferral
To defer 100% of the gain, the replacement property's total acquisition cost has to equal or exceed the net sale price of the property you gave up, and the new debt has to equal or exceed the old debt. Fall short on either and the shortfall becomes taxable. That leftover is called boot.
Shortfall type | What triggers it | Tax consequence |
|---|---|---|
Cash boot | Buying a cheaper replacement property | Difference is taxable (up to your realized gain) |
Mortgage boot | Taking on less debt than you retired | Difference is taxable unless offset by additional cash |
Boot is not taxed at a single rate. Depreciation recapture - the part of your gain that comes from deductions you already took, technically Section 1250 unrecaptured gain - is taxed first, at a maximum of 25%. Anything above that is taxed at federal long-term capital gains rates. High-income taxpayers may also owe the 3.8% Net Investment Income Tax on investment income above certain thresholds ($200K single, $250K married AGI).
The common version of this mistake: paying off a $300,000 mortgage on the old property but taking only a $200,000 mortgage on the new one, without putting in $100,000 of cash to close the gap. Modeling the equity and debt numbers with your QI and CPA before you make offers is what catches it. Partial exchanges - deliberately taking some boot - are allowed and sometimes sensible, but they should be a choice, not a surprise.
Rule 7: The same taxpayer on both sides
Whoever sells the relinquished property has to be the one who buys the replacement, the exact same individual or entity. Selling from one LLC and buying through another breaks the rule even when the same person owns both. So does a married couple selling jointly and taking replacement title individually, or partners in a partnership trying to buy replacement property on their own.
Entity structure is best settled before the exchange. If you need to change entities, a tax attorney can advise on restructuring before or after - not in the middle of - the exchange.
Reporting the exchange on Form 8824
Every completed exchange gets reported to the IRS on Form 8824, filed with your return for the year the exchange began. If it straddles two calendar years - you sell in December and close in February - it still goes on the year-of-sale return. Form 8824 works out the deferred gain and the adjusted basis you carry into the replacement property. That basis is what your CPA uses to set future depreciation and the gain you will recognize whenever you eventually sell. The deferral is not forgiveness; it follows the property forward.
The seven rules are precise, not complicated: how the property is used, like-kind matching, the qualified intermediary, the 45-day identification, the 180-day closing, full reinvestment, and same-taxpayer consistency. Each is a separate test, and all seven have to pass.
Frequently asked questions
Can I extend the 45-day identification deadline?
No. The 45-day deadline is fixed in the tax code and regulations. The only exception is a narrow IRS relief provision for federally declared disasters affecting specific areas. Market conditions, personal circumstances, and financing delays do not extend it.
What if I identify three properties but can't close on any of them?
The exchange fails. Your QI releases the funds and you owe tax on your gain. This is why many advisors identify at least one backup that can close quickly, such as a Delaware Statutory Trust (DST), a fractional interest in real estate that can rescue the exchange if the primary targets fall through.
Is there a minimum holding period for the replacement property?
The statute doesn't specify one. But selling the replacement too soon after the exchange can lead the IRS to argue you never intended to hold it for investment. Most advisors suggest holding replacement property for at least 12 to 24 months. If you already know you'll want to sell quickly, a 1031 exchange may not fit that plan.
Can a revocable trust do a 1031 exchange?
Generally yes, because a revocable (grantor) trust is treated as the same taxpayer as the grantor for income tax purposes. Irrevocable trusts follow different rules, and the trust document must not prohibit 1031 exchange activity. Get tax counsel involved for any trust-held property.
What is a reverse exchange?
A reverse exchange lets you acquire the replacement property before selling the one you're giving up. It's more complex and more expensive, since the replacement is typically "parked" with an Exchange Accommodation Titleholder until the sale closes. In return, it removes the 45-day identification pressure, because you already own the replacement. Reverse exchanges are governed by [Rev. Proc. 2000-37](https://www.irs.gov/pub/irs-drop/rp-00-37.pdf).
Can I do a 1031 exchange if I have a partner or co-owner?
Yes, but every co-owner has to participate in the exchange for their own share, or the non-participating owner's share is taxable. Tenants-in-common can each run their own exchange. Partnership interests themselves don't qualify as like-kind property, though some strategies, such as distributing property to the partners before the exchange, work in certain situations.