1031 Exchange Real Estate: Deadlines, Boot, and Basis

A 1031 exchange lets you defer capital gains tax when you sell an investment property and roll the proceeds into another one, but only if you follow five 1031 exchange rules: both properties must be like-kind real estate held for business or investment, a qualified intermediary must hold the funds, you must identify the replacement within 45 days and close within 180, you must reinvest all your equity and debt to avoid taxable “boot,” and you must report the exchange on Form 8824 with a carried-over basis. Miss any one of them and the whole gain becomes taxable, exposed to federal long-term capital gains rates up to 20%, the 3.8% Net Investment Income Tax, and depreciation recapture at up to 25%.¹

Rule 1: Both Properties Must Be Like-Kind Investment Real Estate

The property you sell (the relinquished property) and the property you buy (the replacement property) both have to be real estate held for productive use in a trade or business or for investment.² Within that category, “like-kind” is broad. A rental duplex is like-kind to a warehouse. An office building is like-kind to raw farmland. What the buildings look like does not matter; what you hold them for does.

Several categories are excluded. Property held primarily for resale, such as a fix-and-flip, does not qualify. Your personal residence does not qualify. Stocks, bonds, partnership interests, and other financial instruments are also excluded.³ If you hold real estate through a partnership, the partnership itself would need to exchange the property at the entity level; a partnership interest is not real property.

One geographic limit matters: U.S. real property is not like-kind to foreign real property.³ A rental condo in Miami can be exchanged for an office building in Portland, but not for a villa in Portugal.

Vacation Homes

A second home you sometimes rent out sits in a gray area. The IRS has a safe harbor that spells out when a dwelling qualifies. For each of the two 12-month periods immediately before the exchange (for the relinquished property) or after the exchange (for the replacement property), the home must be rented at fair market rent for at least 14 days, and your personal use must not exceed the greater of 14 days or 10% of the days it was rented.⁴ A beach house rented 200 days a year and used personally for 12 meets the test. A ski cabin rented one week a year and used every other weekend does not.

Rule 2: A Qualified Intermediary Must Hold the Funds

You cannot touch the sale proceeds. If the money hits your bank account, even briefly, the exchange fails and the full gain becomes taxable. A qualified intermediary (QI) steps into the transaction, holds the funds in a separate account, and uses them to buy the replacement property on your behalf.³ The QI has to be engaged before the relinquished property closes, and at closing the title company wires the net proceeds directly to the QI, not to you.

Not everyone can serve. Anyone who has acted as your agent during the two years before the exchange is disqualified. That rules out your real estate agent, attorney, accountant, and employees.³ The intermediary has to be independent, so the arrangement reads as a genuine third-party exchange rather than you accessing your own money through a proxy.

One risk catches investors off guard: QIs are not federally regulated, and no uniform bonding or insurance rule protects the funds they hold. If the QI goes bankrupt or commits fraud, your proceeds can be lost. Before choosing one, verify fidelity bond and errors-and-omissions coverage, confirm that exchange funds sit in segregated accounts rather than commingled with operating funds, and check that those accounts are at an FDIC-insured institution. Ask for proof.

Rule 3: Meet the 45-Day and 180-Day Deadlines

Two clocks start the day the relinquished property closes. Neither stops for weekends, holidays, or bad market conditions.

The 45-Day Identification Period

By the 45th calendar day after closing, you must deliver a written identification of every potential replacement property to your QI. The identification has to be specific enough that the IRS cannot question what property you meant, so use a street address or legal description. If day 45 passes without a valid written identification, the exchange fails automatically.²

You get three ways to identify:

Three-property rule: identify up to three properties of any value. This is the most common route.
200% rule: identify more than three properties as long as their combined fair market value does not exceed 200% of the relinquished property’s value.
95% rule: identify any number of properties at any value, but you must actually close on at least 95% of the total value identified.

Most investors use the three-property rule because it is simple and has no value cap. The 95% rule is rarely used because failing to close on one identified property can blow up the whole exchange.³

The 180-Day Exchange Period

You must close on the replacement property by the 180th calendar day after closing the relinquished property, or by the due date (including extensions) of your federal tax return for the year of the sale, whichever comes first.² The “whichever is earlier” language trips up investors who sell late in the year. Close a sale in November, and you will not have a full 180 days unless you file for an extension of your return. For any exchange that closes in the final quarter, an extension is effectively mandatory.

The 45-day window sits inside the 180-day window, not on top of it. After spending up to 45 days identifying, you have roughly 135 days left to actually close.

Rule 4: Reinvest Everything to Avoid Taxable Boot

A fully tax-deferred exchange requires reinvesting all the equity from the sale. Any value you receive that is not like-kind real property is called “boot,” and boot is taxable up to the amount of the gain you are trying to defer.² It shows up two ways:

Cash boot: you pull cash out of the exchange, or the replacement property costs less than the net sale price of the relinquished property. The leftover cash is taxable.
Mortgage boot, or debt relief: your new loan is smaller than the loan you paid off. Sell a property with a $500,000 mortgage and buy a replacement with a $400,000 mortgage, and the $100,000 in debt relief is taxable boot.

The working rule is buy equal or up. The replacement’s total purchase price should equal or exceed the net sale price of the relinquished property, and the new debt should equal or exceed the old debt. If the new mortgage is lower, adding cash at closing offsets the debt relief and eliminates the boot.

Closing Costs

Not every dollar leaving the exchange creates boot. Transactional costs tied to the sale or purchase, such as broker commissions, title insurance, recording fees, transfer taxes, and QI fees, can generally be paid from exchange funds without triggering tax. Loan-related costs are different. Loan origination fees and lender-required appraisals are typically not treated as exchange expenses and can create boot if paid from the exchange account. The safer approach is to pay loan costs out of pocket rather than from the QI’s escrow.

Rule 5: Report the Exchange and Track the Basis Carryover

Every 1031 exchange must be reported on IRS Form 8824, filed with the federal tax return for the year the relinquished property was transferred.³ The form details both properties, the timeline, any boot received, and gain recognized or deferred. Even a perfectly executed exchange with zero taxable boot still requires Form 8824.

The deferred gain does not disappear. It moves into the replacement property through basis carryover: the new property’s tax basis equals the old property’s adjusted basis, modified for any boot paid or received.² That low carried-over basis means higher depreciation recapture and a bigger taxable gain when you eventually sell without another exchange.

Depreciation Recapture

The exchange also carries forward all the depreciation you claimed on the relinquished property. When you finally sell in a taxable transaction, that accumulated depreciation is recaptured at a maximum federal rate of 25%, separate from and on top of the long-term capital gains rate. After several exchanges over a career, the accumulated depreciation can be enormous. A string of 1031 exchanges is a powerful wealth-building strategy, but it builds an equally large future tax obligation that needs planning.

Related-Party Exchanges

Exchanging property with a family member or an entity you control triggers extra scrutiny. If you do a 1031 exchange with a related party, both sides must hold their respective properties for at least two years after the exchange. If either side sells within that window, the deferred gain snaps back and becomes taxable in the year of the disposition.⁵ The IRS also has a catch-all that disqualifies any exchange structured as part of a series of transactions designed to sidestep the two-year requirement. Related parties for this purpose include siblings, spouses, ancestors, lineal descendants, and entities in which you own more than 50%.

Reverse and Improvement Exchanges

Not every deal lines up neatly. When you find the replacement before you have a buyer for the relinquished property, a reverse exchange uses a special-purpose entity called an Exchange Accommodation Titleholder to take title to the replacement while you sell the old one. Under the IRS safe harbor, the whole arrangement has to wrap up within 180 days.

An improvement exchange, sometimes called a build-to-suit exchange, lets you use exchange proceeds to construct or renovate the replacement property. You cannot build on property you already own. An unrelated entity has to hold title during construction, make the improvements, and transfer the finished property to you before the 180-day deadline. These structures are complex and require tight coordination between the QI, the accommodation entity, and the construction schedule. Deals that run past the deadline fail, and there is no grace period.

State Tax Considerations

Federal deferral does not guarantee state deferral. Most states follow the federal 1031 rules, but a few either do not conform or impose additional requirements. Some states require non-resident sellers to withhold a percentage of the sale price when investment property changes hands, even in a 1031 exchange, with rates typically ranging from about 3% to 8%. The withholding is usually credited against state tax liability, but cash still leaves the exchange and must be replaced to avoid creating boot. Check the rules in both the state where the relinquished property sits and the state where you are buying before assuming you are fully covered.

1
Internal Revenue Service. Net Investment Income Tax
2
Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment
3
Internal Revenue Service. Like-Kind Exchanges Under IRC Section 1031
4
Internal Revenue Service. Revenue Procedure 2008-16
5
Internal Revenue Service. Revenue Ruling 2002-83