Section 1031 Like-Kind Exchanges: Deferring Tax on Real Property Sales

By Yarik Yarosh, CPA ·September 5, 2026 ·Updated September 23, 2026 ·7 min read

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

A Section 1031 like-kind exchange allows a business owner or real estate investor to sell real property used in a trade or business or held for investment and defer ALL capital gains tax by reinvesting the proceeds into “like-kind” replacement property. After the Tax Cuts and Jobs Act (TCJA) of 2017, only real property qualifies for 1031 exchanges. Personal property (equipment, vehicles, artwork) no longer qualifies. The exchange doesn’t eliminate the tax; it defers it until the replacement property is sold (unless the owner does another like-kind exchange at that time, deferring again). Some investors chain 1031 exchanges for decades, deferring gains until death, at which point the heirs receive a stepped-up basis and the deferred gain disappears permanently.

✓Key takeaway

Section 1031 like-kind exchange rules:

What qualifies:

Real property held for productive use in a trade or business
Real property held for investment (rental property, vacant land)
“Like-kind” is broadly defined for real property: commercial can exchange for residential, improved for unimproved, a warehouse for an apartment building
Does NOT qualify: primary residence (personal use), property held primarily for sale (dealer/flipper inventory), stock, bonds, partnership interests

What does NOT qualify (after 2017):

Equipment, machinery, vehicles
Livestock
Artwork, collectibles
Inventory
These were eligible before 2018 but the TCJA limited 1031 to real property only

Strict timelines:

45-day identification period: the seller must identify (in writing) potential replacement properties within 45 calendar days of closing on the relinquished property
180-day exchange period: the seller must close on the replacement property within 180 calendar days of selling the relinquished property (or by the tax return due date, if earlier)
These deadlines are absolute. Missing either one disqualifies the exchange and the gain is fully taxable.

Three-property rule (identification):

The seller can identify up to 3 potential replacement properties regardless of value
OR any number of properties as long as total FMV doesn’t exceed 200% of the relinquished property’s FMV
OR the 95% rule (must acquire 95%+ of the value identified), used only in large portfolio exchanges

Qualified intermediary (QI) requirement:

The seller cannot touch the proceeds. A qualified intermediary (escrow agent) holds the funds between the sale and the purchase.
If the seller receives the cash at any point, the exchange fails
The QI is typically an attorney or title company specializing in 1031 exchanges
QI fees: $750-$2,000 per exchange

Boot (taxable portion):

If the seller receives any cash or non-like-kind property in the exchange, it’s called “boot” and is taxable
If the replacement property costs less than the relinquished property, the difference is boot
If the mortgage on the replacement property is less than on the relinquished property, the debt relief is boot
To fully defer: the replacement property must be equal or greater in value AND equal or greater in debt

Basis carries over:

The replacement property takes the basis of the relinquished property (adjusted for boot and exchange expenses)
This means lower depreciation on the replacement property
The deferred gain is built into the replacement property’s lower basis

How does a 1031 exchange work in practice?

Hypothetical example

Round numbers. For current guidance, see IRS like-kind exchange guidance. A small business owner sells a commercial building used in their business for $800,000. Original purchase price: $400,000. Depreciation claimed: $150,000. They want to buy a larger building for $900,000.

Without 1031 exchange (straight sale):

Sale price: $800,000
Adjusted basis: $400,000 - $150,000 depreciation = $250,000
Total gain: $800,000 - $250,000 = $550,000
Depreciation recapture (Section 1250): $150,000 x 25% = $37,500
Capital gain: ($550,000 - $150,000) x 20% = $80,000
Net investment income tax: $550,000 x 3.8% = $20,900
Total tax on sale: $138,400
Cash available for new building: $800,000 - $138,400 = $661,600
Need to finance: $900,000 - $661,600 = $238,400

With 1031 exchange:

Sale price: $800,000
Proceeds go to qualified intermediary (seller never touches the cash)
Within 45 days: identify the $900,000 replacement building
Within 180 days: close on the replacement building
Tax on sale: $0 (fully deferred)
Cash available for new building: $800,000
Need to finance: $900,000 - $800,000 = $100,000
QI fee: $1,500
Exchange expenses: $3,000

Comparison:

	Straight Sale	1031 Exchange
Tax paid	$138,400	$0
Cash for new building	$661,600	$800,000
Additional financing needed	$238,400	$100,000
Savings		$138,400 in deferred tax

The 1031 exchange puts $138,400 more toward the new building. That’s $138,400 that stays invested and earning returns instead of going to the IRS.

Basis of replacement property:

Basis of relinquished: $250,000
Plus: additional cash invested ($100,000 + closing costs)
New basis: approximately $350,000 (much lower than the $900,000 purchase price)
Depreciation on the new building is calculated on the $350,000 basis, not $900,000
This means lower annual depreciation deductions going forward

The “swap till you drop” strategy: If the business owner continues doing 1031 exchanges every time they sell a building:

Building 1 ($400K) exchanged into Building 2 ($800K): $0 tax
Building 2 ($800K) exchanged into Building 3 ($1.5M): $0 tax
Building 3 ($1.5M) exchanged into Building 4 ($2.5M): $0 tax
Owner passes away with Building 4

At death:

Heirs receive Building 4 with a stepped-up basis equal to FMV ($2.5M)
All deferred gains from Buildings 1-4 are permanently eliminated
The heirs can sell Building 4 for $2.5M with $0 gain
Total tax paid on all four buildings: $0

This is one of the most powerful wealth-building strategies in the tax code.

Common mistakes that disqualify exchanges:

Receiving the cash directly (must use a QI)
Missing the 45-day identification deadline (no extensions, no exceptions)
Missing the 180-day closing deadline
Buying a replacement property before selling the relinquished property (reverse exchange, possible but complex and expensive)
Converting property to personal use too soon after the exchange
Using the property as a primary residence without meeting the 5-year holding requirement for the Section 121 exclusion

Partial exchange (boot received): If the owner sells for $800,000 but buys replacement for $700,000:

Boot received: $100,000
$100,000 is taxable (at capital gains rates)
$450,000 of gain is deferred
Tax on boot: approximately $25,000
Still saves approximately $113,400 compared to a straight sale

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.

Related guides:

Do suspended rental losses expire if I keep exchanging?

No. A passive loss you can’t use carries forward to the next year as a deduction for the same activity, and it keeps rolling forward each year it goes unused. A 1031 exchange generally doesn’t free those losses, because the gain isn’t fully recognized, but it doesn’t wipe them out either.

They get used in a few ways. Passive income from your other activities absorbs them each year, since the limit applies to your net passive loss. The $25,000 allowance can cover some if you actively participate, own at least 10%, and your modified AGI is under $150,000 (the full amount is available at $100,000 or less). Or they’re freed when you dispose of your entire interest in a fully taxable sale to an unrelated buyer.

For a business owner who trades one building for another, that means keeping a running record of each rental’s suspended losses from year to year. The number will matter on the day you finally sell without exchanging.

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Cite this page

Yarik Yarosh, CPA. "Section 1031 Like-Kind Exchanges: Deferring Tax on Real Property Sales." Blue Cloud CPA, September 5, 2026, updated September 23, 2026. https://bluecloudcpa.com/guides/small-business-section-1031-like-kind-exchange

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