1031 Exchange Rules & Checklist

A 1031 exchange can be an incredible tool for real estate investors to reduce their tax liability. We demystify the rules required to qualify and successfully complete a like-kind exchange.

1031 Exchange Rules | Deferred.com

What is a 1031 exchange?

Named after the relevant section of the Internal Revenue Code, a 1031 exchange is a way for real estate investors to sell a property and buy a replacement without paying capital gains taxes on the transaction.

As an investment strategy, performing a tax-deferred like-kind exchange can be hugely beneficial:

  • Invest in larger properties - an exchange can help investors “trade up” into higher value properties, with more leverage and more potential revenue, without a taxable event.
  • Diversify or consolidate investments - Investors can exchange a single property for multiple properties, allowing them to diversify across property types and geographies. They can also exchange multiple properties for one larger investment, participating in high-value investments that may otherwise be difficult to access.
  • Relief from management - Investors who want to shift from active property management into a more passive investment can exchange into a property with fewer responsibilities, like a commercial property with a triple-net lease or into a Delaware Statutory Trust (DST) managed by a professional.
  • Depreciation - In the case where a property is fully depreciated, an investor can “size up” as part of the exchange and take advantage of additional depreciation to offset investment income.
  • Estate planning - In some cases, an investor may be able to defer taxes forever using the “swap until you drop” strategy, allowing their investment to continue compounding for generations.

Why would Congress and the IRS allow this? Section 1031 has actually been part of the Internal Revenue Code since 1921, and it was implemented with three principles in mind:

  1. Continuity of investment - The investor started and ended with real estate, without any additional cash (or “boot”) in the transaction.
  2. Theoretical gain - If the property is “like-kind” and the investment has continuity, Congress did not want to impose a tax on a theoretical paper gain based on the underlying accounting.
  3. Administrative burden - When Section 1031 was added into the Code, personal property was included as potential property that could qualify for an exchange. There was a clear recognition that the IRS would have a difficult time detecting, evaluating, and auditing a large number of personal property trades — specifically barters and horse trading.

While the specific laws governing like-kind exchanges have evolved over time, the basic underlying principles have largely stayed the same.

Free Resources

Before we do a deep dive into the specific rules to qualify for a 1031 exchange, know that they can be complex, detail oriented, and highly specific to the circumstances. Have a burning question about your particular situation? We built ARTE, a free AI chatbot trained on hundreds of tax documents and case law, to help you get instant answers. You can ask ARTE anything about 1031 exchange and get a personalized answer here.

1031 Question? Ask ARTE

Our free AI 1031 Expert is trained on 1,000+ pages of US tax law and passes all accreditation exams


1031 Rules Downloadable Checklist

We’ve also made a downloadable checklist to help you navigate your own exchange. Fill out your information here to get the free checklist.

Anatomy of a 1031 Exchange

To understand the rules required to complete a successful 1031 exchange, first you must understand the key players and the structure of a successful transaction.

Remember, Congress allows for 1031 Exchanges when the property is “like-kind” and there’s a “continuity of investment”. To enforce this, property that is included in an exchange passes through a “Qualified Intermediary”. They’ll work with the real estate investor (also referred to as the “exchanger” or “taxpayer”) to complete the process.

This Qualified Intermediary, or QI, is a neutral third party that helps “facilitate” your exchange. An exchanger needs to start with real estate and end with real estate, and cannot receive any cash or other non-like-kind property through the transaction. In a property structured 1031 exchange, the QI takes over the real estate, completes the sale of the relinquished property, holds the proceeds in escrow, and completes the purchase of any replacement property on behalf of the taxpayer. While the QI works at the direction of the taxpayer doing the exchange, from the perspective of the IRS the taxpayer started with real estate and ended with real estate, and the QI helped the taxpayer “keep their hands clean” to avoid a taxable event.

While there are many specific rules that must be met (and we dive much deeper into them below), all qualifying transactions must use a Qualified Intermediary and follow this rough transaction structure.

Property Rules in a 1031 Exchange

What type of property can be exchanged?

Only real property can be exchanged, which has a very specific definition as it relates to the tax code.

Real Property means any land, whether raw or improved, and includes structures, fixtures, appurtenances and other permanent improvements, excluding moveable machinery and equipment. Real Property includes land that is served by the construction of Project infrastructure (such as roads, sewers and water lines) where the infrastructure contributes to the value of such land as a specific purpose of the Project.

Historically, personal property qualified for an exchange, but this was updated by Congress as part of the Tax Cuts and Jobs Act in 2017. If an investor is buying or selling real estate and the exchange includes personal property like fixtures, furniture, equipment, or appliances, these items are not considered “like-kind” and the value may be taxed.

Similarly, other types of investment assets that do not qualify as real property are not eligible for a tax-deferred exchange. This includes:

  • Stocks, Bonds, Notes
  • Other securities or debt
  • Partnership interests
  • Certificates of trust

Real Property 1031 exchange

Relinquished & Replacement Properties

In an exchange, you have “relinquished” properties that a taxpayer is selling in the process. There are also “replacement” properties that are bought throughout the process. In most cases, the qualifying property rules apply to both relinquished and replacement properties, but when this is not the case we’ll call it out below and use these terms to help clarify.

Qualifying Property Rules

Real Property Rule

As mentioned above, both the relinquished and replacement property must be Real Property based on the definition in the tax code. They cannot be securities, equities, debts, partnership interests, or any type of personal property.

Property Type Rule 

The real property must be a qualifying property type. Many different types of real property qualify, not just traditional real estate, and some types may be unexpected. Qualifying property types include:

Rental properties

  • Single Family Rental
  • Duplex, Triplex or fourplex
  • Apartment Building
  • Hotel


  • Office Building
  • Shopping or retail center
  • Warehouse or distribution centers
  • Triple net lease property


  • Vacant land or farm land

Fractional ownership

  • TIC interest in real property
  • DST interest in real property
  • Leasehold Interests
  • Co-op interests
  • Timeshares (assuming it’s deed based and not usage based)


  • Mineral, water or timber rights
  • Oil and gas interests
  • Unharvested crops
  • Gravel or quarry rights

Entity Type Rule

The property must be held in a qualifying type of entity. This includes:

  • Ownership by an individual
  • Ownership by spouses, jointly or individually
  • Single Member LLCs
  • Partnerships
  • S corporations
  • C corporations
  • Trusts
  • Charitable Organizations
  • Retirement Accounts

Held for Investment

As mentioned before, there must be a “continuity of investment”. Property must be held long term and for investment purposes. Specifically, the tax code says properties must be held either for productive use in a trade or business or for investment purposes.

There are a few rules that a property will be tested against to determine if a property is held for investment.

Property Held for Business Use or as an Investment

The property must clearly be used as part of a business or as an investment. It cannot be used for personal reasons, and Section 1031 explicitly carves out properties that serve as the taxpayers Primary Residence or as a second/vacation home.

In the case where a property was previously a taxpayer’s primary residence or a second home, there is the potential to convert the property to an investment. Taxpayers can also combine Section 121 exclusions (deferring capital gains on a primary residence) with a 1031 exchange on a converted property to reduce their overall capital gains taxes.

Inventory Rule

Properties cannot be held as inventory or dealer properties, where the intent is to buy and quickly sell the property for a gain. “Fix and Flip” properties, as an example, are not considered “held for productive use or as an investment” and do not qualify for 1031 exchanges. From an accounting perspective they are “held as inventory”, and they do not meet the Holding Period Rules (more on that below).

In the case where a property is owned by a business, ensure the property is categorized as Held For Investment/Income in the accounting ledgers to avoid any potential issues.

Holding Period Rules

Similar to the point above about dealer inventory, a property must be held for a certain period of time to qualify for an exchange. While there is no hard and fast rule, it’s generally advisable to hold the property as an investment for two tax reporting periods (and to report the property as an investment with your filings). This means holding the property for as little as 13 months in some cases.

Note that this holding period rule applies to both relinquished AND replacement properties. As part of Publication 1035, the IRS can audit a taxpayer for any filing within the prior 3 years. If you successfully complete a 1031 exchange, but then do not meet the holding period rule on your replacement property, your exchange may be recharacterized as a taxable sale and you may be subject to capital gains taxes after the fact.

While there are some allowances for exceptional or unforeseen cases, quickly selling a replacement property after completing an exchange is an easy way to end up with a major tax bill. Have concerns about a previous 1031 exchange? You can ask ARTE about your personal situation.

Like-Kind Property Rules

The relinquished property and the replacement property must be “like-kind” to qualify for an exchange. An easy way to think about this is that the replacement property must have a similar use (in business or as an investment) as the relinquished property.

The property does not have to be an “exact match” in an exchange, and based on the qualifying property types an investor can mix-and-match in an exchange. To determine if a property is like-kind, the IRS has a few simple rules.

Matching Territory Rule

The property must be in the same territory. From the perspective of the tax code, this means either foreign or domestic property.

  • Domestic US property can only be exchanged for other domestic US property.some text
    • Property owned in US territories that are not part of the 50 states, such as Puerto Rico or the US Virgin Islands, may have different treatment.
  • Foreign (Non-US) property can only be exchanged for other Foreign (Non-US) property.

Matching Purpose Rule

This is one of the most important rules, but also maybe one of the most open-ended in a way that can be confusing for the average real estate investor. Technically, to meet this rule:

  • If property is held for investment purposes, like kind property must also be held for investment.
  • If property is used for business purpose, like kind property must also be used for business purpose.

What does this mean in practice? It means that you can exchange many different property types and they can be consider “like-kind” as long as they’re used in a similar way. The “investment purpose” part of this test can include properties that are held for income (like a rental) or appreciation (like raw land), and exchanging between the two (exchanging raw land for an income producing rental) is totally acceptable.

Some common examples that qualify:

  • Exchanging two income producing properties held for investment - This could be a single family home for a multi-family building, a short term rental for a commercial building, a hotel for a duplex, etc.
  • Exchanging two properties for business use - If a corporation or business is performing an exchange, you could exchange between two office buildings serving as headquarters for the business, vacant land for a warehouse, etc.
  • Fractional ownership interests - This could be an exchange between two fractional ownership interests, like a TIC interest in a commercial building for a share of a DST owning like-kind property. It could also include exchanging an individual, wholly-owned property into a fractional DST interest, or vice versa, a DST interest into a single property.

One thing to be wary of is you cannot exchange properties across purposes. If property is used for business it cannot be exchanged for investment purposes, or vice versa. For example, a business that owns a warehouse to store their inventory cannot exchange into a property that is held for investment, like a vacation rental or a multi-family apartment complex.

Entity Ownership Rules

The entity that owns the relinquished property must be the same entity purchasing the replacement property. Back to our overview of 1031 exchange transaction structures, the IRS is looking for a “continuity of investment”, and that includes a continuity of the owner making that investment!

This could be straightforward, but because real estate is often owned by different types of entities (like an LLC) and there are multiple ways to vest title for a property, it can get complicated quickly. There are a few key points to consider when it comes to entity ownership.

Consistent Ownership Rule

The entity doing the exchange must meet the holding period requirements for all properties. This includes any relinquished property prior to sale and any replacement property post-closing. Investors often want to change the ownership entity for various reasons, which can lead to two common problems

  • Changing entities prior to sale - If title to any relinquished property is transferred to a new entity prior to an exchange, and an exchange is attempted before the holding period rule is satisfied, the exchange could be recharacterized and potentially taxable.
  • Changing entities after acquisition - If title to any replacement property is transferred to a new entity after an exchange is completed, and before the holding period rule is satisfied, the exchange could be recharacterized and potentially taxable.

Disregarded Entity Exceptions

There are some exceptions to the Consistent Ownership rule. In some cases, an entity may be “disregarded” in the eyes of the IRS. A common instance of this is a single member LLC, where the LLC does not file a tax return and instead is consolidated with the member’s taxes. In cases like this, where an entity is “disregarded” for tax purposes, it is possible to complete an exchange by selling a property from the disregarded entity and acquiring a replacement property within the taxpaying entity.

Spousal Ownership Exceptions

Another potential exception to the Consistent Ownership rule has to do with joint spousal ownership. In the case where two married people own a property jointly, they both must be on the title to the replacement property.

The caveat is that in community property states, where asset ownership between spouses is considered joint property, then specific vesting language on title is less important. Property owned by the spouses jointly can be replaced with a property owned by an individual spouse and vice versa.

Fractional Ownership Rules

A fractional interest in a property can be part of a 1031 exchange. For example, if an investor owned a 50% tenancy-in-common interest in a duplex, upon the sale of the duplex they could exchange their proceeds into a replacement property. 

It does not matter if the other fractional owners in the relinquished property intend to do their own exchanges or not. Fractional interests in a property can be exchanged for other fractional interest in a property or whole property.

Understanding how the fractional ownership interest translates to an individual’s cost basis, sale proceeds, and mortgage relief amounts can be tricky. If you have specific questions we recommend asking ARTE or speaking with a professional.

LLC and Partnership Interest Rules

What if you own part of an entity that has invested in real estate, like an LLC or a Partnership? In this case there are a few rules and considerations.

  • LLC or Partnership interests cannot be exchanged - Remember, 1031 exchanges only work for real property. Your ownership in the shared entity is a security and does not qualify. some text
    • For example, exchanging your interest in one LLC for an interest in another does not qualify.
  • The LLC or Partnership can perform an exchange - Assuming the entity owns real property, the entity itself can perform a 1031 exchange. some text
    • For example, an LLC with many owners can vote to sell a duplex and purchase an apartment building as a replacement. This can work long as the LLC remains intact and the members do not change.
  • Drop & Swap to dissolve entity - If the owners of an entity want to dissolve entity go their separate ways, but they also want the tax advantages of a 1031 exchanges, they would need to do what is called a “drop and swap”. This strategy is a way to convert the property to a fractional interest that is eligible for an exchange by each individual owner.some text
    • For example, the entity is dissolved, the property is distributed to the owners, and entity owners become fractional owners of the property on an individual basis. Once the property is “dropped” from the entity down to the shareholders, each individual can “swap” their fractional interest in a 1031 exchange (assuming all other requirements are met). Sales can happen jointly (at the whole property level) or on a fractional basis, and each individual’s sale and/or exchange does not impact other owners.

Related Party Rules

To ensure an exchange is a true “continuity of investment” and not otherwise a tax-avoidance scheme, the sale and purchase of properties must be “arms-length” and the parties involved must not be related.

Related Party Transaction 1031 exchange

These rules can get complex, if you have a specific scenario you’re interested in that may involve a related party we suggest you ask ARTE or consult with a professional. At a high level, a “related party” includes

  • Any transaction involving a spouse, parents and grandparents, brothers and sisters, and kids and grandkids.
  • Any transaction with an entity where more than 50% of the entity is held by a related party.
  • In the case of a trust or an estate, any executors, trustees or beneficiaries of the estate are considered a related party.

Process Rules in a 1031 Exchange

In addition to the process rules listed above, a 1031 must be performed in a very specific way for the taxpayer to defer capital gains.

Exchange Agreement Rules

Remember the transaction structure we described at the start of our post? One major component of the structure is having the appropriate documentation in place with your qualified intermediary. This includes having an exchange agreement that meets certain requirements as well as property or sale-purchase agreement assignments. These agreements, particularly the exchange agreement, must also be executed prior to the sale of the relinquished property to be effective.

Cash Handling Rules

To achieve the “continuity of investment”, the exchanger needs to start with real estate and end with real estate. One of the primary ways that is accomplished is by ensuring the exchanger has “restricted access to funds” throughout the exchange, and there are a number of rules that must be met to qualify.

Constructive Receipt Rules

At no point can the exchanger take “constructive receipt” and have access to the funds. The exchanger cannot touch the proceeds of the sale of the relinquished property in any way, otherwise they will be taxed. This rule is more strict than it seems on the surface. IRS Publication 538 defines constructive receipt as:

Constructive receipt - Income is constructively received when an amount is credited to your account or made available to you without restriction. You do not need to have possession of it. If you authorize someone to be your agent and receive income for you, you are considered to have received it when your agent receives it. Income is not constructively received if your control of its receipt is subject to substantial restrictions or limitations.

A common issue for a potential exchanger is the title company providing a check for the proceeds. Even if you do not cash the check, the fact that the funds have been “made available to you without restriction” means that you’ve taken constructive receipt and are no longer eligible for an exchange.

Constructive Receipt 1031 exchange

Qualified Intermediary Rule

To meet the “Constructive Receipt” rule and structure the transaction appropriately, exchangers must use a Qualified Intermediary. The Qualified Intermediary must receive the proceeds from the sale of relinquished property, hold them throughout the exchange process, and deliver the funds used for any replacement property purchases. If any sale proceeds are transferred from the Qualified Intermediary to the taxpayer they’ll be considered “boot” and are taxable.

The rules are vague when it comes to who can serve as a qualified intermediary. Some states have specific requirements, but for the most part intermediaries do not need to be licensed or have any formal training. This can present an incredible risk when attempting an exchange, it’s important to find the right qualified intermediary who has experience with like-kind exchanges and can be trusted to hold your funds.

A Qualified Intermediary is mostly defined based on who is ineligible for the role (called a disqualified person). According to the Regulations for Section 1031, this includes anyone who has worked for the taxpayer within the last two years as an “employee, attorney, accountant, investment banker or broker, or real estate agent or broker”. It also includes related parties, such as family members. You can read more about what a Qualified Intermediary does here.

Taxable Boot Distribution Rules

Any remaining cash that is taxable must be held through the end of the exchange, otherwise the entire transaction may be considered taxable.

A key part of meeting the “constructive receipt” rule is limiting the taxpayers access to the funds until the exchange is complete. The rules for this can be complex based on a particular situation, but generally:

  • If no replacement property is identified, exchange funds can be released after the 45 day identification period is complete.
  • If replacement property is identified but not acquired, exchange funds can be released after the 180 day exchange timeline is complete.
  • If all identified replacement property has been acquired, remaining exchange funds can be released.

Again, any funds released will be considered taxable boot. As long as the rules around the release of cash are met, any funds used as part of the exchange can count towards a partial tax deferral and the taxpayer will only be taxed on the amount dispersed.

Exchange Timeline Rules

There are a number of time-based rules that must be met in the exchange process. You can read our deep dive on 1031 exchange timelines, but we’ll summarize the rules below.

Exchange Timeline Start

The timeline for an exchange starts with the sale of a relinquished property.

  • In most cases, this will be the closing date referenced on the closing documents for the relinquished property.
  • In cases where multiple properties are sold as part of an exchange, the date of the earliest sale will start the timeline.
  • In cases where there is not an outright transfer of property (any sort of carry back, holdback or contract for deed), the clock starts when the risk of ownership is transferred. some text
    • One way to determine when the risk is transferred - who is responsible for the property if it were to burn down? 
    • In most cases this will be the closing date, but it could vary depending on the structure of the sale agreement.

Timeline Calculation Rules

The start date (as described above) is considered day 1 of the timeline. All relevant dates are calculated according to the following rules:

  • All timelines are calculated based on calendar days. Timelines are not impacted by business days
  • No adjustments for holidays or weekends
  • No adjustment for operating hours of a title company, county recorder’s office, etc.
  • In rare cases, the timeline can be extended based on declared disasters or emergencies

45 Day Identification Rule

If the exchange has not been completed within 45 days, the final list of identified properties must be signed and provided to the QI within 45 days of the closing of the earliest sale of the relinquished property.

  • If all replacement properties are acquired prior to the 45 day mark, no identification is required
  • Deadline for identification is midnight of the 45th day
  • The identification must meet the other Replacement Property Identification Rules listed below

180 Day Purchase Rule

The exchange must be completed, with all replacement property acquisitions complete, by the 180th day.

  • Replacement property acquisition deadline is midnight of the 180th day
  • Any replacement property acquired after the end of the 180th day cannot be included to offset capital gains taxes, regardless of what stage of the closing process the property has reached by the end of the exchange
  • In the case of construction or improvement exchanges, all work identified as part of the replacement property must also be completed as part of the deadline

Tax Filing Rule

The exchange must be complete prior to the taxpayer filing taxes for the year in which the exchange occurred. Because the taxpayer must report the exchange in the year the relinquished property is sold, if taxes are filed with an exchange in-process, the exchange will be disqualified and considered a taxable sale.

This matters most when the exchange straddles tax years. For example, an individual selling in December of 2023, the 180 day timeline would push into May, but tax filings are due April 15th. If the exchange is not complete by April 15th, the customer would need to file an extension for their 2023 taxes. This rule is more complex, and even more important, for entity types that have quarterly tax filing requirements.

Replacement Property Identification Rules

To successfully complete an exchange, replacement property must either be purchased within 45 days or potential replacement properties must be identified. A valid identification must meet the following criteria.

Identification Letter Rules

Based on Section 1031 regulations, a valid identification must include specific property as targets for replacement, be:

  • Made in a written document
  • Signed by the exchanger(s)
  • Delivered before the 45 day identification deadline
  • Delivered to any person involved in the exchange other than the taxpayer or a disqualified person
    • Most often, this letter would be delivered to the Qualified Intermediary facilitating the exchange

An identification letter can also be revoked or replaced within the 45 day identification period using the same process of delivering a signed document to the same party the original identification was provided to, and within the 45 day identification window.

Number of Identified Properties

Whether or not replacement properties satisfy identification rules depends on how many properties are identified. There are three rules to consider and they are based on the number of properties included in the letter.

  • Three Property Rule - Exchangers can identify up to three properties as potential replacement properties without regard to their total fair market value. An exchanger could purchase a single property on this list, two properties, or all three. This is the most straightforward rule and often works for most exchangers who are looking at a limited number of potential replacements.
  • 200-Percent Rule - If an exchanger wants to identify more than three properties, they can qualify for the 200% rule if the total fair market value of all the properties identified does not exceed 200% of the total fair market value of the relinquished properties sold in the exchange. With this rule, an exchanger can purchase any combination of these properties as replacements.some text
    • For example, if you sold a property for $100,000, you could identify more than three replacement properties as long as their combined value does not exceed $200,000.
  • 95-Percent Rule: This rule applies if an exchanger does not meet the other rules – they identify more than 3 properties and the total fair market value of replacement property is greater than 200% of the value of relinquished property. Under the 95-Percent Rule, you must acquire 95% of the identified replacement properties before the end of the exchange period. This rule is rarely used because the requirements are very stringent and the penalty for acquiring less than 95% of identified properties is high - the entire exchange is disqualified.some text
    • For example, if you sold one property for $1,000,000 and identified 10 replacement properties worth $200,000 each under this rule, you would use the 95% rule. To have a successful exchange you would either need to acquire 95% of the properties (which means acquiring all 10!) or you would need to hit 95% of the value ($1,900,000) across all replacement property acquisitions.

Taxable Boot Rules

There are some basic rules that must be met to maximize your tax deferral and avoid “boot”, which is an accounting term defined as “Cash or other property added to an exchange to make the value of the traded goods equal”. We won’t go deep into how boot is calculated in an exchange. If you’re interested in learning more check out our free 1031 Exchange Calculator.

boot 1031 exchange

Equal or Up Rule

The simple way to ensure an exchange maximizes deferred taxes and avoids a capital gain is to trade for replacement properties that are “equal or up” - they are worth more than the relinquished property that is sold. For example, selling a property worth $100,000 and acquiring a property worth $100,000 or more would avoid a taxable gain.

Cash Boot Rules

All proceeds from the sale of relinquished property must be “rolled over” and invested into the replacement property. Any cash proceeds removed from exchange or leftover after all replacement properties are purchased will be taxable.

Any non-cash property received in the exchange will also be taxed as Boot. For example, if an exchanger sells a ranch worth $500,000 and traded for a ranch worth $400,000 plus farming equipment (like tractors) worth $100,000, the $100,000 in equipment would be considered Boot and the value would be taxed as capital gains.

Mortgage Boot Rules

To successfully exchange properties, the value of any relinquished mortgages must be replaced. This can be accomplished by getting a new mortgage (with a loan amount that is “equal or up”) on the replacement property, or by investing additional cash as part of the transaction to replace the loan. If the value of the mortgage is not replaced with the purchase of the new property, the value of the mortgage will be considered taxable boot.

This can be a difficult rule to understand. Let’s take an example where an exchanger sells a property worth $100,000 and that has a $50,000 mortgage that is paid off as part of the sale. To complete a valid exchange, when the exchanger purchases replacement property they will need to either:

  • Purchase a property worth $100,000 (or more) with a purchase money mortgage of $50,000 (or more) to replace the loan that was paid off.
  • Purchase a property worth $100,000 (or more) with an additional investment of $50,000 (or more) to replace the loan that was paid off.

If the exchanger purchases property worth $50,000 in all cash, with no new mortgage and no additional investment, the $50,000 mortgage value that was paid off is considered mortgage boot and will be taxed as a capital gain.

Partial Exchange Rules

Assuming all other rules are met, if an exchange is completed and there is taxable boot at the end, the exchanger qualifies for a partial exchange and will only be taxed on the amount of boot.

For example, if an exchanger sells $100,000 in property with a $50,000 mortgage, and they acquire $90,000 in replacement property with a $50,000 mortgage, there would be $10,000 in cash boot leftover in the exchange. In this case, the exchanger deferred most of their capital gains taxes and would only be taxed on the remaining $10,000.

In some cases, an exchanger may want some cash in hand as part of the transaction (to pay down debt, invest in things other than real estate, make a major purchase, etc.) This is completely acceptable and would not disqualify the exchange assuming they meet all of the cash handling rules.

To better understand how taxable gains are determined in a partial exchange, check out our 1031 Exchange Calculator to run some scenarios.

Exchange Reporting Rules

Once an exchange is complete, the taxpayer must report it to the IRS. To meet this rule, a taxpayer must:

  • Establish the basis in the new replacement property - This would be based on the cost basis of the relinquished property, adjusted based on the details of the exchange (including any fees, costs, and additional investments)
  • Report the exchange in the appropriate year - The exchange must be reported for the year where the relinquished property was sold.some text
    • Remember, based on the Tax Filing Rule, you cannot file taxes while in the process of an exchange or the exchange will be disqualified
  • File for 8824 - This simple form can be completed by you or with the help of a CPA and must be included with your tax file.

The risk of an exchange is always based on whether or not a taxpayer is audited. An exchange will not be approved, denied, or otherwise reviewed by the IRS unless an audit occurs, so be sure to file appropriately and save any supporting documentation. Generally the IRS can review returns filed within the last three years based on the statutes of limitations, but in cases where there are substantial errors additional years may be reviewed.

State Specific 1031 Exchange Rules

While Section 1031 is in the federal tax code, and the rules apply across all states, some states have implemented their own additional rules to successfully complete an exchange.

While we’re not going to list the details for every state in this post, you can go here to see 1031 rules for a specific state. A few interesting states worth noting -

  • Nevada - Nevada has specific requirements around who can serve as a Qualified Intermediary, with the goal of offering additional protections for exchangers above and beyond federal requirements.
  • California - California arguably has the most state-specific rules when it comes to like-kind exchanges. There are additional reporting requirements (both upfront and annually), clawback provisions, and other considerations when selling property in California as part of an exchange.
  • Washington - Washington has local Real Estate Excise Taxes (REET) that have special treatment when performing an exchange.
  • Notably Florida, Georgia, and Texas, which are all popular markets for real estate investors, do not have any state-specific rules for 1031 exchanges.

1031 Exchange Rules Checklist

That is the complete list of 1031 exchange rules. Want this article in the form of a checklist? Submit your information here to get the free checklist.

1031 Question? Ask ARTE

Deferred's AI 1031 Expert trained on 1,000+ pages of tax law passes all accreditation exams


Frequently Asked Questions

What is the three property rule in a 1031 exchange?
What is the 200% rule in a 1031 exchange?
What is the 95% rule in a 1031 exchange?
How long must you hold property in a 1031 exchange?
How do I report a 1031 exchange to the IRS?
How many properties can you identify in a 1031 exchange?
What does "boot" mean in a 1031 exchange?
What properties qualify for a 1031 exchange?
What qualifies as like-kind property in a 1031 exchange?
What is the role of a qualified intermediary in a 1031 exchange?
What happens if I miss the 45-day or 180-day deadline?

Related Articles