A 1031 exchange, named after Section 1031 of the Internal Revenue Code, lets an investor sell one investment property and buy another without paying capital gains tax on the sale right away. The tax is deferred as long as the proceeds are reinvested in like-kind real property and the investor follows strict rules and deadlines.
Investors use exchanges to trade up to larger buildings, move into a new market, or shift from management-heavy properties to simpler ones while keeping more equity working.
How it works
The basic sequence for a delayed exchange, the most common type, looks like this:
- Hire a qualified intermediary (QI) before the sale closes. The QI holds the sale proceeds. If you take control of the money yourself, the exchange can fail.
- Sell the relinquished property. Proceeds go straight from escrow to the QI.
- Identify replacement property within 45 days of the sale, in writing.
- Close on the replacement property within 180 days of the sale (or by your tax return due date, if earlier).
Key rules to know:
- Like-kind is broad for real estate. An apartment building can be exchanged for raw land, a retail center or a single-family rental, as long as both are held for investment or business use. Since 2018, only real property qualifies.
- Identification limits. Most investors use the three-property rule (identify up to three properties of any value) or the 200% rule (any number of properties whose combined value is no more than twice the sale price).
- Boot is taxable. Cash you keep, or a reduction in debt that you do not replace, is called boot and is generally taxed.
- Same taxpayer. The person or entity that sells must generally be the one that buys.
Example
Say a hypothetical investor bought a duplex years ago for $400,000 and has claimed $90,000 of depreciation. They sell it for $750,000. Without an exchange, they would owe tax on a gain of roughly $440,000, including depreciation recapture.
Instead, they route the proceeds through a QI, identify three small apartment buildings by day 30, and close on a $1,100,000 building by day 150, reinvesting all the equity and taking on a larger loan. Because they kept no cash and did not reduce their debt, the full gain is deferred into the new property.
Why it matters for landlords
A 1031 exchange can be one of the most powerful tools for growing a rental portfolio, because money that would have gone to taxes stays invested. It also requires planning: you need a QI, a realistic list of replacement properties and a closing timeline that fits the 180-day window.
Good records make the process smoother. The replacement property inherits the old property’s tax basis, so you will need clean depreciation and purchase records. TenantLoop accounting keeps those records organized, and our 1031 exchange accounting article explains how to book the transaction. This is general information, so work with a CPA or tax attorney before you start an exchange.
Related terms
Where it gets confusing.
Can I do a 1031 exchange on my primary residence?
No. A 1031 exchange applies to real property held for investment or for use in a trade or business. A personal residence has its own separate tax rules for gains on sale.
What happens if I miss the 45-day or 180-day deadline?
The exchange generally fails and the sale is treated as a taxable sale. The deadlines are strict, so most investors line up a qualified intermediary and replacement options before closing on the sale.
Do I ever pay the deferred tax?
The tax is deferred, not erased. If you later sell without doing another exchange, the deferred gain and depreciation recapture typically come due. Ask a CPA how this applies to your situation, and see our 1031 exchange rules article for more.