1031 Exchange Rules for Real Estate Investors: 45 Day, 180 Day, Boot, and Basis Rules
A Section 1031 exchange can defer federal income tax when an investor exchanges qualifying business or investment real estate for other qualifying real estate.
The transaction is not simply a sale followed by the purchase of another property. Federal law imposes specific requirements concerning the property, the exchange structure, control of the sale proceeds, identification of replacement property, and the time allowed to complete the exchange.
A successful exchange also does not eliminate the gain. The unrecognized gain is generally preserved through the tax basis of the replacement property and can become taxable in a later disposition unless another nonrecognition rule applies.
For broader real estate planning guidance, see my Real Estate Tax Planning resource page.
Key Tax Takeaways
- Section 1031 currently applies only to qualifying real property.
- Both the relinquished property and replacement property must be held for investment or productive use in a trade or business.
- Property held primarily for sale to customers generally does not qualify.
- In a deferred exchange, replacement property must generally be identified within 45 days.
- The replacement property must generally be received within 180 days or by the due date of the tax return, including extensions, if earlier.
- A qualified intermediary is commonly used to prevent the taxpayer from receiving or controlling the sale proceeds.
- Cash or other nonqualifying property received can create taxable gain commonly referred to as boot.
- Debt relief can also affect recognized gain.
- There is no statutory rule requiring the replacement mortgage itself to equal or exceed the old mortgage.
- The replacement property's basis generally preserves the deferred gain.
- Partnership interests generally do not qualify for Section 1031 treatment.
- Related party exchanges require additional review.
- Reverse and improvement exchanges require specialized structures.
- Section 1031 generally does not release all suspended passive activity losses because the exchange is not a fully taxable disposition.
What Property Qualifies for a 1031 Exchange?
Section 1031 currently applies only to real property held for productive use in a trade or business or for investment.
Common qualifying property can include:
- Residential rental property
- Apartment buildings
- Office buildings
- Warehouses
- Retail property
- Industrial property
- Farm and ranch real estate held for qualifying purposes
- Vacant land held for investment
- Certain leasehold and other qualifying real property interests
Real estate can generally be exchanged across property types. An apartment building does not have to be exchanged for another apartment building. For example, qualifying rental property can generally be exchanged for qualifying commercial property or investment land.
What Property Does Not Qualify?
Property generally does not qualify merely because it is real estate.
Potential exclusions include:
- A principal residence held primarily for personal use
- Real estate held primarily for sale to customers
- Property acquired primarily for immediate resale
- Foreign real property exchanged for United States real property
- Partnership interests
- Stock, securities, notes, and similar financial interests
Dealer Property Is Different From Investment Property
A developer, builder, or investor who acquires property primarily to sell it to customers can have inventory or dealer property rather than investment property. The taxpayer's intent and actual activity should be reviewed before assuming that Section 1031 applies.
How Does a Deferred 1031 Exchange Work?
In the most common structure, the investor transfers the relinquished property to a buyer and uses a qualified intermediary to facilitate the exchange.
The taxpayer generally cannot receive or have unrestricted control over the sale proceeds and later decide to reinvest them. Receiving the funds can cause the transaction to be treated as a taxable sale rather than an exchange.
The qualified intermediary generally receives the exchange proceeds and then uses those funds to acquire the replacement property for transfer to the taxpayer.
The 45 Day Identification Rule
Replacement property generally must be identified no later than 45 days after the taxpayer transfers the relinquished property.
The identification must satisfy the regulatory requirements and clearly describe the property, typically using a street address, legal description, or other unambiguous description.
The 45 Day Deadline Is Usually Not Extendable
Difficulty finding replacement property, financing delays, negotiations, or changes in market conditions generally do not extend the identification deadline. Limited relief can exist when the IRS grants disaster related postponements.
How Many Replacement Properties Can Be Identified?
The regulations provide several identification rules.
Three Property Rule
The taxpayer can identify as many as three replacement properties without regard to their fair market values.
200 Percent Rule
The taxpayer can identify more than three properties if the total fair market value of all identified properties does not exceed 200 percent of the total fair market value of all relinquished properties.
95 Percent Rule
If the taxpayer exceeds those limits, identification can still be respected in certain cases when the taxpayer actually acquires qualifying identified properties whose aggregate value is at least 95 percent of the aggregate fair market value of everything identified.
The 180 Day Exchange Period
Replacement property must generally be received by the earlier of:
- The 180th day after transfer of the relinquished property, or
- The due date of the taxpayer's federal income tax return for the year of the transfer, including extensions.
When an exchange begins late in the calendar year, filing an extension can be important if the normal return due date would otherwise end the exchange period before 180 days have elapsed.
What Is Boot in a 1031 Exchange?
Section 1031 can provide complete or partial deferral.
When the taxpayer receives cash, nonqualifying property, or certain net debt relief, part of the realized gain can become taxable.
Example: Investor Keeps $100,000 of Sale Proceeds
Assume:
- Relinquished property fair market value is $1,000,000.
- Adjusted basis is $400,000.
- Realized gain is $600,000.
- The investor acquires qualifying replacement property for $900,000.
- The investor receives $100,000 of cash.
Ignoring liabilities and other adjustments for this simplified example, the taxpayer can generally recognize $100,000 of gain while deferring the remaining $500,000.
Do I Have to Replace the Same Amount of Debt?
There is no standalone statutory requirement that the new mortgage equal or exceed the old mortgage.
Instead, liabilities are part of the overall exchange calculation. Relief from debt can be treated as money received, while liabilities assumed on replacement property and additional cash contributed can affect the net result.
The common advice to purchase property of equal or greater value and reinvest all net equity is a useful planning framework for complete deferral, but the actual federal gain calculation should be performed rather than relying solely on a mortgage comparison.
How Is the Basis of the Replacement Property Determined?
The deferred gain is generally carried into the replacement property through its tax basis.
Example: Full Deferral Preserves the Gain
Assume:
- Relinquished property is worth $1,000,000.
- Adjusted basis is $400,000.
- Realized gain is $600,000.
- Replacement property costs $1,200,000.
- The entire transaction qualifies for deferral.
The replacement property does not simply receive a $1,200,000 federal tax basis. In this simplified example, the $600,000 deferred gain reduces the replacement property's basis to approximately $600,000.
Can Partnership Interests Be Exchanged Under Section 1031?
A partnership interest generally does not qualify as Section 1031 real property.
The partnership itself can exchange real estate that it owns, but an individual partner generally cannot exchange a partnership interest for replacement real estate.
Transactions in which partners distribute property before an exchange or contribute property after an exchange are sometimes referred to as drop and swap or swap and drop transactions. These structures require careful analysis of ownership, holding purpose, timing, partnership tax rules, and transaction substance.
Can a Vacation Property Qualify?
A dwelling unit with both investment and personal use can present a holding purpose question.
Revenue Procedure 2008 16 provides a safe harbor for certain dwelling units. Among other requirements, the property must generally be owned for at least 24 months before the exchange for relinquished property or 24 months after the exchange for replacement property.
In each of the two relevant 12 month periods, the property generally must be rented at fair rental value for at least 14 days, and personal use generally cannot exceed the greater of 14 days or 10 percent of the days rented at fair rental value.
Failure to meet the safe harbor does not necessarily prove that the property fails Section 1031, but the taxpayer then must rely more heavily on the complete facts concerning investment intent.
What Is a Reverse 1031 Exchange?
A reverse exchange can be useful when the taxpayer needs to secure replacement property before the relinquished property has been sold.
Revenue Procedure 2000 37 provides a safe harbor using an exchange accommodation titleholder. Among the requirements, a written qualified exchange accommodation agreement generally must be entered into within five business days, the relinquished property generally must be identified within 45 days when replacement property is parked, and the applicable property generally cannot remain parked beyond 180 days.
Reverse exchanges should be structured before the taxpayer acquires the replacement property.
What Is an Improvement Exchange?
An improvement exchange can allow exchange funds to be used for qualifying improvements to replacement property before the taxpayer receives the completed replacement property.
This generally requires an accommodation structure because improvements made after the taxpayer already owns the property generally cannot simply be treated as replacement property received in the exchange.
Related Party Exchanges Need Special Review
Section 1031(f) contains special rules for exchanges involving related parties.
A later disposition of the exchanged property by either related party within two years can generally trigger recognition of previously deferred gain unless a statutory exception applies.
Indirect related party transactions through an intermediary can also require analysis.
How Does a 1031 Exchange Affect Depreciation Recapture?
Section 1031 can defer qualifying gain that otherwise would be recognized on a property disposition, but depreciation classifications still matter.
Cost segregation components, Section 1245 property, Section 1250 property, recognized boot, and replacement property classification can affect the amount and character of recognized and deferred gain.
For more information, see Depreciation Recapture on Rental Property .
Does a 1031 Exchange Release Suspended Passive Losses?
Generally not merely because the property was exchanged.
Section 469(g) generally releases all suspended passive losses when the taxpayer disposes of the entire interest in the passive activity to an unrelated person in a fully taxable transaction.
A qualifying Section 1031 exchange is not a fully taxable disposition to the extent gain is deferred.
See Suspended Passive Rental Losses .
California Investors Have an Additional Reporting Layer
When California real estate is exchanged for property outside California, federal deferral does not necessarily eliminate California's claim to tax the deferred California source gain when it is later recognized.
California Form FTB 3840 can create continuing annual reporting requirements.
See California 1031 Exchanges and Deferred Gain .
What Records Should Be Kept?
- Original purchase closing statement
- Historical depreciation schedules
- Cost segregation studies
- Relinquished property closing statement
- Qualified intermediary agreement
- Written replacement property identification
- Replacement property closing statement
- Debt payoff and new financing records
- Form 8824
- Federal and state basis schedules
- California Form FTB 3840 when applicable
Frequently Asked Questions
How long do I have to identify replacement property?
Generally 45 days after transfer of the relinquished property.
How long do I have to complete the exchange?
Generally 180 days after transfer of the relinquished property or the due date of the federal income tax return, including extensions, if earlier.
Can I receive the sale proceeds and reinvest them later?
Generally not in a standard deferred exchange. Actual or constructive receipt of the proceeds can cause the transaction to fail. A qualified intermediary is commonly used to prevent that result.
Do I have to buy the same type of real estate?
Generally no. Qualifying United States real property held for business or investment can have broad like kind treatment with other qualifying United States real property.
Can I exchange into a DST?
Certain Delaware statutory trust interests structured consistently with Revenue Ruling 2004 86 can qualify as an interest in real property for Section 1031 purposes.
Can I exchange a partnership interest?
Generally no. A partnership interest is excluded, although the partnership itself can potentially exchange qualifying real estate.
Does a 1031 exchange eliminate tax permanently?
No. It generally defers recognized gain by carrying the deferred gain into the basis of the replacement property.
Model the 1031 Exchange Before the Sale Closes
I assist real estate investors with Section 1031 tax planning, including basis, depreciation, recognized gain, boot, debt, replacement property, passive losses, California reporting, and the tax consequences of alternative transaction structures.
Schedule a ConsultationThis article provides general federal income tax information. Section 1031 treatment depends on property use, ownership, transaction structure, timing, identification, control of proceeds, debt, related parties, depreciation history, and other facts.
