Definition
A 1031 exchange, named for Section 1031 of the tax code, lets a real estate investor defer capital gains tax by reinvesting the proceeds from selling an investment property into another like-kind property.
How It Works
When the rules are followed, no tax is due at the sale. The deferred gain carries into the basis of the replacement property and can be deferred again through future exchanges. The process is governed by strict deadlines: the investor identifies replacement property within 45 days of selling, closes within 180 days, uses a qualified intermediary to hold the funds rather than taking possession, and reinvests equal or greater value and debt to defer the full amount.
Example
An investor sells a rental for $1 million with a $400,000 gain and rolls the full proceeds into a larger property through a qualified intermediary, deferring tax on the $400,000.
When It Works Best
It fits investors who want to keep capital working in real estate and move up in property size or quality without triggering tax at each step.
Who It Applies To
Owners of investment or business real estate. It does not apply to a primary residence.
Watch-Outs
Any cash or debt relief taken out of the deal, known as boot, is taxable. Missing the 45 or 180-day deadlines disqualifies the exchange. The replacement property must be identified precisely and the intermediary must be in place before the sale closes.
