Like-Kind Exchange (IRC 1031): How to Defer Capital Gains on Commercial Property Sales

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

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

A like-kind exchange under IRC 1031 allows a taxpayer to sell investment or business-use real property and defer all capital gains tax by reinvesting the full proceeds in a replacement property of equal or greater value. Since the TCJA (effective January 1, 2018), 1031 exchanges apply ONLY to real property (land, buildings, commercial property, rental property). Personal property (equipment, vehicles, art, collectibles) no longer qualifies. The exchange doesn’t eliminate the tax: it defers the gain by reducing the basis of the replacement property. But with proper planning (including a stepped-up basis at death under IRC 1014), the deferral can become permanent. The exchange must be structured through a qualified intermediary (QI) who holds the sale proceeds in escrow, because the taxpayer must never have “constructive receipt” of the funds. Two strict deadlines apply: 45 days to identify the replacement property and 180 days to complete the acquisition.

✓Key takeaway

IRC 1031 exchange rules (post-TCJA):

Element	Rule
Property that qualifies	Real property held for investment or business use
Property that does NOT qualify	Personal residence, inventory (dealer property), stocks, bonds, partnership interests, equipment, vehicles
Like-kind definition	Very broad for real estate: any real property for any other real property (office for apartment, land for retail, etc.)
45-day identification period	Must identify replacement property within 45 calendar days of sale
180-day exchange period	Must acquire replacement property within 180 calendar days of sale
Qualified intermediary required?	Yes (taxpayer can’t touch the funds)
Boot (cash or non-like-kind property received)	Taxable to the extent of gain
Debt relief	Treated as boot if not replaced with equal or greater debt on replacement property

Identification rules (45-day deadline):

Rule	Limit
3-property rule	Identify up to 3 properties (any value)
200% rule	Identify any number of properties if total FMV doesn’t exceed 200% of the relinquished property’s FMV
95% rule	Identify any number, but must acquire 95% of the total identified value

What happens to the deferred gain:

Scenario	Tax Result
Exchange into equal or greater value property	100% deferral
Exchange into lesser value property (receive boot)	Partial deferral (boot is taxable)
Sell replacement property outright (no further exchange)	All deferred gain becomes taxable
Die while holding replacement property	Stepped-up basis under IRC 1014, deferred gain eliminated permanently
Gift replacement property	Recipient takes carryover basis (deferred gain transfers to recipient)
Convert to personal use	Partial recognition may apply

How does a 1031 exchange save taxes?

Hypothetical example

Round numbers. A real estate investor sells a rental property and reinvests in a larger property.

The relinquished property (property being sold):

Item	Amount
Original purchase price	$500,000
Improvements added	$100,000
Total cost basis	$600,000
Accumulated depreciation (10 years at 27.5-year SL)	($218,182)
Adjusted basis	$381,818
Sale price	$900,000
Total gain	$518,182

Gain breakdown:

Component	Amount	Tax Rate
Depreciation recapture (IRC 1250, unrecaptured Sec. 1250 gain)	$218,182	25%
Long-term capital gain	$300,000	20%
NIIT (3.8% on total)	$518,182	3.8%

Option A: Sell outright (no 1031 exchange)

Tax	Calculation	Amount
Depreciation recapture (25%)	$218,182 x 25%	$54,545
LTCG (20%)	$300,000 x 20%	$60,000
NIIT (3.8%)	$518,182 x 3.8%	$19,691
State tax (~5%)	$518,182 x 5%	$25,909
Total tax		$160,145
After-tax proceeds	$900,000 - $160,145	$739,855

Option B: 1031 exchange into replacement property ($1,000,000)

Item	Amount
Replacement property price	$1,000,000
Down payment from exchange proceeds	$900,000
New mortgage	$100,000
Tax on exchange	$0 (fully deferred)
Basis of replacement property	$381,818 (carryover basis from relinquished property) + $100,000 (new cash/debt) = $481,818
Deferred gain carried forward	$518,182

Comparison:

Metric	Outright Sale	1031 Exchange
Tax paid now	$160,145	$0
Cash available to reinvest	$739,855	$900,000
Additional buying power		$160,145 (the tax money stays invested)

The investor retains $160,145 more capital by deferring the tax. Over 10 years at a 7% annual return, that $160,145 grows to $315,000+, demonstrating the wealth-building power of 1031 exchanges.

Boot: when partial tax is owed If the investor buys a $800,000 replacement property instead of $1,000,000:

Item	Amount
Sale proceeds	$900,000
Replacement property price	$800,000
Boot received (cash not reinvested)	$100,000
Gain recognized (lesser of boot or total gain)	$100,000
Tax on boot (blended rate ~30%)	$30,000
Deferred gain	$418,182

Debt replacement requirement: The investor must replace debt as well as equity. If the relinquished property had a $200,000 mortgage and the replacement has no mortgage:

Item	Amount
Debt relief (mortgage paid off at sale)	$200,000
Debt on replacement property	$0
Mortgage boot	$200,000 (treated as boot received)

To avoid mortgage boot: the replacement property must have equal or greater debt, or the investor must add additional cash to offset the debt reduction.

The swap-till-you-drop strategy:

Year	Action	Tax
Year 1	Buy Property A ($300,000)	N/A
Year 10	1031 exchange to Property B ($600,000)	$0
Year 20	1031 exchange to Property C ($1,200,000)	$0
Year 30	Owner dies, Property C gets stepped-up basis to $1,800,000 FMV	$0
Heirs sell	Heirs sell Property C for $1,800,000	$0 (stepped-up basis = FMV)

Total capital gains tax paid across all transactions: $0. The gain that accumulated through a lifetime of exchanges was permanently eliminated by the stepped-up basis at death under IRC 1014.

1031 exchange timeline:

Day	Deadline
Day 0	Close on sale of relinquished property. Proceeds go to qualified intermediary.
Day 1-45	Identify replacement property (must be in writing, signed, delivered to QI)
Day 45	HARD DEADLINE: identification must be complete
Day 46-180	Acquire replacement property
Day 180	HARD DEADLINE: must close on replacement property

Both deadlines are absolute, with no extensions (not even for weekends or holidays). Missing the 45-day identification deadline by one day collapses the entire exchange and triggers immediate taxation.

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

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Cite this page

Yarik Yarosh, CPA. "Like-Kind Exchange (IRC 1031): How to Defer Capital Gains on Commercial Property Sales." Blue Cloud CPA, September 5, 2026. https://bluecloudcpa.com/guides/small-business-like-kind-exchange-1031-commercial-property

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