Using 1031 Exchanges to Defer Capital Gains Tax
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Section 1031 exchanges allow real estate investors to swap one investment property for another without immediately paying capital gains tax. Named after IRS code §1031, this strategy helps you preserve equity and grow your portfolio by deferring tax on appreciated assets.
To qualify, you must exchange “like-kind” property held for business or investment purposes. This can include:
- Residential or commercial real estate
- Vacant land used for investment
- Properties in different states
You cannot exchange personal residences, dealer properties (flip inventory) or stocks/bonds.
Key deadlines drive a 1031 exchange:
- 45-day identification period: From the sale date, you have 45 days to list up to three replacement properties in writing to a qualified intermediary.
- 180-day exchange period: You must close on one or more identified properties within 180 days of the sale escrow closing.
If you miss these windows, the IRS treats your transaction as a taxable sale.
Common exchange structures include:
- Delayed exchange: Most popular—seller closes first, funds held by an intermediary, then you buy replacement.
- Simultaneous exchange: Rare—both closings occur on the same day.
- Reverse exchange: You acquire replacement property before selling the relinquished asset.
While a 1031 exchange defers federal (and often state) capital gains tax, buyers are recommended to verify current rules with a tax professional. You’ll still owe depreciation recapture tax and eventual gains when you sell without another exchange.
Before pursuing a §1031 exchange, assemble these essentials:
- Qualified intermediary agreement
- List of identified replacement properties
- Proof of intent that both properties are held for investment
For detailed IRS guidance, see the IRS Publication 544. It’s advisable to consult a licensed attorney or CPA who specializes in 1031 exchanges to navigate deadlines, documentation and state-specific considerations.
