Tax planning
Section 1031 Exchange: How to Defer Capital Gains Tax When Selling Real Property
A 1031 exchange lets you sell investment real estate and defer the capital gains tax indefinitely — if you reinvest in like-kind property following strict timelines. The identification window is 45 days; the close window is 180 days. Here's how it works and where it fails.
Written by Matt Reese, CPA · 7 min read · Published April 2026·Share on LinkedIn
Key Takeaways
- A 1031 exchange defers capital gains tax and depreciation recapture when you sell investment real property and reinvest in another like-kind property. The gain isn't eliminated — it's deferred until the replacement property is sold (or until death, at which point heirs receive a stepped-up basis).
- Two critical deadlines: identify replacement property within 45 days of closing the sale; close on the replacement property within 180 days. Both are absolute and cannot be extended.
- A qualified intermediary (QI) is required — you cannot touch the sale proceeds yourself. The exchange fails if the proceeds are deposited in your account before the replacement purchase closes.
- Since TCJA 2017, 1031 exchanges only apply to real property. Personal property (equipment, aircraft, artwork) no longer qualifies.
How a 1031 exchange works
Under Section 1031, when you sell a property held for investment or used in a trade or business, you can defer tax on the gain if you:
- Use a qualified intermediary (QI) to hold the sale proceeds — you never receive them yourself
- Identify one or more replacement properties within 45 days of the sale closing
- Close on the replacement property within 180 days of the sale closing
- Reinvest the full proceeds into a property of equal or greater value
If all four conditions are met, you recognize no gain on the sale. The deferred gain and accumulated depreciation carry over into the new property through a lower adjusted basis — which will be realized (and taxed) when you eventually sell the replacement property without doing another exchange.
A 1031 exchange doesn’t eliminate the capital gains tax — it defers it indefinitely. Done correctly in a portfolio strategy, it can defer for decades or until death, at which point the deferred gain disappears with the stepped-up basis.
The basis carry-over mechanism
The tax deferral works by reducing the basis in the replacement property:
The replacement property is purchased for $800,000 but has an adjusted basis of only $326,923. When you eventually sell the replacement property, you'll have a larger gain — but in the meantime, the tax on $473,077 has been deferred, and you've been using the full $800,000 to generate income and appreciation instead of writing a check to the IRS.
The 45-day and 180-day rules
These deadlines are among the most unforgiving in the tax code:
| Deadline | What must happen | If missed |
|---|---|---|
| Day 45 | Identify potential replacement properties in writing to the QI | Exchange fails — full gain taxable |
| Day 180 | Close on the replacement property | Exchange fails — full gain taxable |
| Extension available? | No — absolute deadline | No exceptions for holidays, death, disaster (unless presidentially declared) |
The identification must describe the property specifically — address, legal description, or other clear designation. You can identify up to three properties (Three-Property Rule) or more under specific rules. Most exchangors use the Three-Property Rule: identify up to three and close on one or more.
Start looking before you close the sale
When a 1031 exchange is most valuable
| Situation | Exchange value |
|---|---|
| Long-held, heavily appreciated and depreciated property | Highest — large deferred gain and recapture, significant tax deferral |
| California resident selling CA real property | Very high — combined federal (23.8%) + CA (13.3%) = ~37% total deferred |
| Owner planning to hold real estate for many years | High — multiple sequential exchanges can compound deferral over decades |
| Owner in retirement who may hold property until death | Very high — stepped-up basis at death eliminates all deferred gain |
| Owner who needs liquidity from the sale | Low — 1031 requires full reinvestment; can't pocket proceeds without triggering tax |
| Owner exchanging into lower-income property | May not justify — if replacement generates less income, the deferral cost (complexity, fees) may not be worth it |
Qualified intermediaries and reverse exchanges
A qualified intermediary (QI) is a required element of any 1031 exchange. The QI holds the sale proceeds between closing the relinquished property and closing the replacement property. You cannot receive the proceeds yourself — even temporarily — without disqualifying the exchange.
QI fees typically run $750–$2,500 for a standard exchange. Choose a QI that is bonded, insured, and a member of the Federation of Exchange Accommodators (FEA). The QI is holding your proceeds — solvency matters.
A reverse exchange allows you to acquire the replacement property before selling the relinquished property — useful when you find the replacement first. Reverse exchanges are more complex, more expensive (QI fees of $3,000–$8,000+), and have the same 45-day and 180-day deadlines running from the replacement property acquisition.
Coordinate with your CPA before the sale, not after
You might also read
Capital Gains Tax Rates: Long-Term vs Short-Term, State Tax, and the NIIT Surcharge
Long-term gains are taxed at 0%, 15%, or 20% federally. Short-term gains are ordinary income. Add California's 13.3% and the 3.8% NIIT, and California business owners face effective rates above 37% on long-term gains — and above 54% on short-term.
Tax planningDepreciation Recapture: Why Selling Business Assets Costs More Than You Expect
When you sell a depreciated business asset, the IRS recaptures those deductions — taxing the gain up to the amount of depreciation taken at ordinary income rates. Section 1245 vs Section 1250, the impact of bonus depreciation, and how recapture affects business sales.
Tax planningNet Investment Income Tax: The 3.8% Surtax That Surprises High-Earning Business Owners
The 3.8% NIIT applies to investment income for individuals above $200,000 in modified AGI — on top of regular income tax and capital gains rates. It applies to passive business income, rental income, and gains from selling a business.
Frequently asked
Questions owners actually ask
- Can I exchange an apartment building for a commercial building?
- Yes — 'like-kind' under Section 1031 is broadly interpreted for real property. A residential rental property can be exchanged for commercial real estate, raw land, a retail building, or any other real property held for investment or business use. The 'like-kind' standard essentially means any U.S. real property for any other U.S. real property. You cannot exchange U.S. property for foreign property.
- Can I exchange my rental property for my primary residence?
- Not directly — primary residences are excluded from 1031 exchange rules. However, there's a planning strategy: exchange into a rental property, rent it for at least 2 years (demonstrating investment intent), then convert it to a primary residence and potentially qualify for the Section 121 exclusion ($250,000/$500,000) after meeting the primary residence requirement. This requires careful planning and timing.
- What happens if I can't find a replacement property in time?
- If you fail the 45-day identification or 180-day close deadline, the exchange fails. The full gain and depreciation recapture become taxable in the year of sale. You cannot extend these deadlines — they run concurrently from the closing date and don't pause for weekends or holidays. This is why working with a QI and starting the replacement search before you close the sale is essential.
- What is 'boot' and how is it taxed?
- Boot is cash or other non-like-kind property received in the exchange. If you sell a $500,000 property and only reinvest $450,000, you receive $50,000 of boot — that boot is taxable as gain (and potentially recapture) in the year of the exchange. To defer all gain, you must reinvest all net proceeds (after exchange fees and costs) and acquire a replacement property equal to or greater in value than the relinquished property.
- How does the step-up in basis at death work with a 1031?
- This is a significant estate planning benefit of 1031 exchanges. If you exchange into a property, carry forward the deferred gain your whole life, and leave the property to heirs at death, the heirs receive the property at a stepped-up basis equal to fair market value at the date of death — the deferred gain and all accumulated depreciation recapture disappear. The combination of lifetime 1031 exchanges and the stepped-up basis at death can effectively eliminate capital gains tax on real estate held for life.
Take the next step
Turn tax questions into a plan. Talk with Matt or see how we work with operating business owners.
Educational content only.This article is for informational purposes and does not constitute tax, legal, or investment advice. Every owner’s facts are different; consult a qualified CPA and advisor before acting. Tax and accounting services are provided through Matt Reese, CPA; investment advisory services are provided through Measured Risk Portfolios, a registered investment adviser. Matt Reese, CPA and Measured Risk Portfolios are separate entities; clients are not required to engage both.