1031 Like-Kind Exchange: Deferring Capital Gains on Real Estate Sales

By Yarik Yarosh, CPA ·September 5, 2026 ·Updated September 23, 2026 ·6 min read

Written by Yarik Yarosh, CPA (US & Canada) September 5, 2026 · FL CPA license AC61704 · CPA Ontario

A 1031 like-kind exchange allows a business owner or investor to sell real property used for business or investment and defer all capital gains and depreciation recapture taxes by reinvesting the proceeds into replacement property. Since TCJA (2017), 1031 exchanges apply only to real property (not equipment, vehicles, or other personal property). The tax deferral is potentially permanent: if the owner holds the replacement property until death, the heirs receive a stepped-up basis and the deferred gain is eliminated entirely.

✓Key takeaway

1031 exchange requirements:

Like-kind property. Both the relinquished (sold) and replacement (purchased) properties must be real property held for business or investment use. “Like-kind” is broadly defined: an office building can be exchanged for raw land, a rental house can be exchanged for a commercial building, and a warehouse can be exchanged for an apartment complex. The use (business/investment) matters, not the property type.
45-day identification period. The taxpayer must identify potential replacement properties in writing within 45 calendar days of closing on the relinquished property. Up to 3 properties can be identified (regardless of value), or any number if their total FMV doesn’t exceed 200% of the relinquished property’s value.
180-day closing period. The replacement property must be acquired within 180 calendar days of the relinquished property’s closing date (or by the tax return due date, including extensions, whichever is earlier).
Qualified intermediary (QI) required. The seller can’t receive or control the sale proceeds. A QI holds the funds between the sale and the purchase. If the seller touches the money, the exchange fails.
Boot. Any cash or non-like-kind property received in the exchange is “boot” and is taxable. If the replacement property costs less than the relinquished property, the difference is boot. If the mortgage on the replacement is less than the mortgage paid off on the relinquished, the debt relief is boot.
Can’t exchange with related parties. If either party is related (family members, controlled entities), additional restrictions apply (2-year holding requirement under IRC 1031(f)).

How much tax does a 1031 exchange defer?

Hypothetical example

Round numbers. For current guidance, see IRS like-kind exchange guidance. A business owner sells a commercial building for $800,000. Original purchase price: $500,000. Depreciation taken: $150,000. Adjusted basis: $350,000.

Without 1031 exchange:

Sale price: $800,000
Adjusted basis: $350,000
Total gain: $450,000
Depreciation recapture (Section 1250, 25% rate): $150,000 x 25% = $37,500
Remaining capital gain ($300,000 at 20% rate): $300,000 x 20% = $60,000
Net investment income tax (3.8% on $450,000): $17,100
State tax (5% estimate): $22,500
Total tax: $137,100

With 1031 exchange (acquiring $900,000 replacement property):

Tax due now: $0
All gain deferred
New property basis: $350,000 (carryover basis) + $100,000 (additional cash invested) = $450,000
The deferred gain of $450,000 is embedded in the lower basis of the replacement property

If the owner holds the replacement until death:

Heirs receive stepped-up basis to FMV at death
The $450,000 deferred gain is eliminated permanently
Total tax savings: $137,100

If the owner does another 1031 exchange later:

The deferral continues indefinitely
Each exchange carries the deferred gain forward into the next property
“Swap till you drop” is the common strategy: keep exchanging until death, when the step-up eliminates all deferred gains

Illustrative numbers only, not a real client and not advice for your facts.

What are the strict deadlines for completing a 1031 exchange?

A 1031 exchange imposes two non-negotiable deadlines. You have 45 calendar days from the date you sell the relinquished property to identify potential replacement properties in writing to the qualified intermediary. You must close on the replacement property within 180 calendar days of the sale (or by the due date of your tax return, including extensions, whichever comes first). These deadlines cannot be extended, even for weekends or holidays. If you miss either deadline, the entire exchange fails and the full gain becomes taxable in the year of the original sale.

What are the tax implications of converting a rental property to personal use?

Converting a rental to personal use triggers several tax consequences. You stop claiming depreciation, which means no further Schedule E deductions for the property. Any suspended passive losses from the rental activity remain suspended until you dispose of your entire interest in the activity in a fully taxable transaction to an unrelated party. The property’s adjusted basis (original cost minus accumulated depreciation) carries over. When you eventually sell, you owe depreciation recapture tax (25% rate) on the depreciation previously claimed. If you live in the property for 2 of the 5 years before sale, you may qualify for the Section 121 exclusion ($250,000/$500,000), but the gain attributable to post-2008 rental periods is not excludable.

Related guides:

When is a property I plan to exchange a passive rental?

When the payments you get are mainly for the use of the property. The tax code calls that a rental activity, and a rental activity is passive by default whatever your level of participation. A leased commercial building or a long-term rental house fits, and a net passive loss from it generally isn’t allowed for the year; it carries forward instead.

A few properties fall outside the rental activity definition:

Average guest stays of 7 days or less (total days of all stays divided by the number of stays)
Average stays of 30 days or less with significant personal services
Rentals where extraordinary personal services are provided

Falling outside it doesn’t make a loss non-passive, though. The activity is then tested as a trade or business, passive unless you materially participate.

The label matters at exchange time. Suspended losses from a passive rental generally aren’t freed by a 1031 exchange, because the gain isn’t fully recognized. They’re freed by a fully taxable sale of your entire interest to an unrelated buyer.

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Cite this page

Yarik Yarosh, CPA. "1031 Like-Kind Exchange: Deferring Capital Gains on Real Estate Sales." Blue Cloud CPA, September 5, 2026, updated September 23, 2026. https://bluecloudcpa.com/guides/small-business-like-kind-exchange-1031

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.