What are the disadvantages of a 1031 exchange?

A 1031 exchange (also called a “deferred exchange”) lets real estate investors and businesses defer capital gains taxes when they sell one investment or business property and purchase another. Think of it as an interest-free loan from the IRS that keeps more of your equity working for your next deal. Powerful, yes—but it’s not a free lunch. The rules are strict, the timelines are tight, and the strategy doesn’t fit every situation. For a deeper primer, see our 1031 Exchange Rules & Checklist.

Below are the real-world tradeoffs to understand before you start.

1. You Must Use a Qualified Intermediary (QI)

The IRS requires a Qualified Intermediary to hold proceeds from your sale and coordinate the exchange. A good QI protects the exchange, documents everything correctly, and keeps funds segregated and secure. Most QIs charge fees and vary widely in service quality. (At Deferred, we offer No Fee 1031 exchanges, share interest earned on exchange funds, and hold client money in FDIC-insured, segregated accounts—backed by around-the-clock support from an expert team.)

2. Like-Kind and Use Rules Limit What Qualifies

To qualify, both the relinquished and replacement properties must be held for investment or for productive use in a trade or business. “Like-kind” is broad for real property (e.g., you can exchange a rental duplex for a retail condo), but personal residences and personal-use property don’t qualify. You also can’t swap into non-real-estate assets like stocks or bonds.

3. The Clock Is Strict—and Can Drive Sub-Optimal Decisions

Two deadlines define every exchange: you have 45 days after closing to identify replacement property and 180 days to close on the acquisition. These are hard deadlines. In competitive markets, that time pressure can push buyers to compromise on location, price, or due diligence just to “keep the exchange alive.” For timing specifics and planning tips, review The 1031 Exchange Timelines.

4. Need Liquidity? Options Beyond a 1031

Not every scenario calls for deferring taxes via an exchange. If you need quick liquidity or can’t meet the 45/180-day timelines, one option for homeowners is a sale-leaseback through platforms like Sell2Rent, which lets you unlock equity and stay in place as a tenant. Other alternatives include a straightforward sale (and redeploying after taxes), moving into passive real estate like a DST, or using a cash-out refinance to access equity without selling.

5. Basis and Depreciation Carry Over

A 1031 exchange defers taxes—it doesn’t erase them. Your cost basis and depreciation generally carry over to the new property, which can reduce depreciation deductions post-exchange. When you eventually sell in a taxable transaction, deferred gains (including potential depreciation recapture) become due unless you execute another exchange.

6. Debt Replacement and “Boot” Risks

If you had debt on the relinquished property, you generally need to replace that debt (or add equivalent cash) on the replacement property. Any cash you take out or debt you fail to replace can create “boot,” which is taxable. Financing missteps are a common way exchanges become partially taxable.

7. Complexity, Coordination, and Potential Costs

Exchanges introduce paperwork, escrow logistics, lender coordination, identification rules (e.g., three-property rule), and strict wiring controls. Errors can invalidate an exchange. While many investors find the benefits worth it, the process is more complex than a standard sale and purchase. (Deferred’s modern platform is built to simplify these steps—transparent timelines, secure funds flow, and expert support—so you can focus on the deal, not the mechanics.)

Bottom Line

For many investors, a 1031 exchange is an excellent way to preserve equity, compound returns, and level up into better assets. But it isn’t always the right tool—especially if you’re on a tight timeline, need cash now, or want flexibility that the rules don’t allow. If you’re weighing tradeoffs, our team can help you compare scenarios side-by-side and execute a seamless, secure exchange when it’s the right move.

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