Guides
1031 Exchange: How a Like-Kind Exchange Defers Tax
A 1031 exchange lets a real estate investor sell business or investment property and roll the entire sale proceeds into a replacement property without paying capital gains tax at the time of sale. Named for Internal Revenue Code Section 1031, the technique defers the gain by carrying the old property’s tax basis into the new one. The tax is postponed, not erased. It comes due when the investor eventually sells for cash without exchanging again.
The mechanism rests on a simple idea: if you never take the money, you have not cashed out, so there is nothing to tax yet. To make that work, the transaction has to route through a qualified intermediary, stay inside strict deadlines, and reinvest all the value. Miss any of those, and part or all of the gain becomes taxable now.
What a 1031 exchange is
A 1031 exchange is a swap of one real property held for business or investment use for another of “like kind,” structured so the capital gain is deferred rather than recognized. The properties do not have to be identical. Under IRS rules, almost any U.S. real estate held for investment qualifies as like kind to almost any other, so an apartment building can be exchanged for raw land, a warehouse, or a retail strip.
Two conditions define eligibility. Both the property sold (the relinquished property) and the property bought (the replacement property) must be held for productive use in a trade or business or for investment. A primary residence, a fix-and-flip held as inventory, and stock or partnership interests do not qualify.
The gain that would otherwise be taxed is deferred, and the deferral can repeat. An investor can exchange into a larger property, then exchange again years later, compounding the untaxed equity across a career. This is sometimes called “swap till you drop,” because heirs may receive a step-up in basis at death that can eliminate the deferred gain entirely.
Real property only after the TCJA
Since January 1, 2018, Section 1031 applies to real property only. The Tax Cuts and Jobs Act of 2017 removed personal property from the like-kind rules. Before 2018, taxpayers could exchange equipment, vehicles, machinery, artwork, and other tangible or intangible assets. That is no longer allowed.
Today, only real property held for business or investment qualifies. Machinery, business vehicles, collectibles, and franchise rights that were once exchangeable now trigger a fully taxable sale. The change narrowed 1031 into a real estate tool, which is how it is used almost exclusively in 2026.
Real property includes land and generally anything permanently attached to it. Certain incidental personal property that transfers with the real estate can be treated as part of the exchange in limited cases, but the bulk of the value has to be real property to qualify.
The qualified intermediary requirement
A qualified intermediary (QI) is a neutral third party that holds the sale proceeds between the two closings so the investor never takes possession of the cash. If the seller receives the money directly, even briefly, the IRS treats it as constructive receipt and the exchange fails. Engaging the QI before the relinquished property closes is mandatory, not optional.
The QI performs several functions in sequence:
- Enters into an exchange agreement with the taxpayer before the sale closes.
- Receives the proceeds from the relinquished property directly at closing.
- Holds the funds in a segregated account during the identification and exchange periods.
- Uses those funds to acquire the replacement property and transfers it to the taxpayer.
The QI cannot be the taxpayer’s agent, such as their attorney, accountant, or real estate broker who has served them within the two years before the exchange. This independence is what preserves the deferral. The deeper timing mechanics, including the 45-day and 180-day deadlines and reverse exchanges, govern how long the QI can hold the funds and when the replacement must close.
Boot: the part that gets taxed
Boot is any value received in the exchange that is not like-kind real property, and it is taxable up to the amount of the realized gain. Cash taken out at closing is the most common form. Debt relief also counts: if the mortgage on the old property is larger than the mortgage on the new one, the difference is treated as boot unless offset by new cash the investor puts in.
Boot triggers partial recognition. The investor recognizes gain equal to the lesser of the boot received or the total realized gain, and defers the rest. Receiving $100,000 in cash on a deal with $400,000 of realized gain means $100,000 is taxed now and $300,000 stays deferred.
To defer the full gain, an investor generally follows two rules: buy replacement property of equal or greater value, and reinvest all the net proceeds. Taking any cash out, or trading down to a cheaper property, creates boot. Recognized boot can carry depreciation recapture, taxed at up to 25% on prior real estate depreciation, plus the 3.8% net investment income tax where it applies.
Deferred gain vs recognized gain
Realized gain is the full economic profit on the sale. Recognized gain is the portion taxed in the current year. Deferred gain is the remainder, pushed into the future through the replacement property’s basis. In a fully qualifying exchange with no boot, recognized gain is zero and the entire realized gain is deferred.
The three figures always reconcile: realized gain equals recognized gain plus deferred gain. A clean exchange defers everything. A partial exchange with boot recognizes some and defers the rest. A straight sale recognizes all of it.
| Scenario | Cash / boot received | Gain recognized now | Gain deferred | Basis in replacement |
|---|---|---|---|---|
| Full 1031 exchange, all proceeds reinvested | $0 | $0 | $400,000 | $300,000 (carryover) |
| Partial exchange, $100,000 cash taken | $100,000 | $100,000 | $300,000 | $300,000 |
| Straight sale, no exchange | $700,000 | $400,000 | $0 | n/a (sold) |
The example assumes a property with a $300,000 adjusted basis (original $400,000 cost less $100,000 of depreciation) sold for $700,000, for a $400,000 realized gain.
Basis carryover: how the deferred gain is preserved
The replacement property takes a carryover (substituted) basis, which is what keeps the deferred gain alive for later taxation. Rather than getting a fresh basis equal to its purchase price, the replacement property inherits the adjusted basis of the relinquished property, adjusted for boot and any new cash or debt added.
A working shortcut: the basis in the replacement property equals its purchase price minus the deferred gain. In the full-exchange example, a $700,000 replacement property minus $400,000 of deferred gain gives a $300,000 basis, exactly the old adjusted basis carried across.
That lower basis is the deferred tax waiting in the wings. Because depreciation going forward is calculated on the carried-over basis, not the higher purchase price, the investor claims smaller annual deductions than a straight buyer would. When the replacement property is finally sold in a taxable transaction, the built-in gain, plus any new appreciation, is recognized then.
Frequently asked questions
Does a 1031 exchange eliminate capital gains tax?
No. A 1031 exchange defers capital gains tax, it does not eliminate it. The gain carries into the replacement property through a reduced basis and is recognized when that property is sold in a taxable transaction. Investors who exchange repeatedly and hold until death may pass the property to heirs, who can receive a stepped-up basis that erases the deferred gain.
What is the 45-day and 180-day rule?
After selling the relinquished property, the investor has 45 days to identify potential replacement properties in writing and 180 days to close on one. Both clocks start on the closing date of the sale and run concurrently, so the 180-day period includes the first 45 days. These deadlines are strict and generally cannot be extended.
Can I do a 1031 exchange on my primary residence?
Generally no. Section 1031 applies to property held for business or investment, not a personal residence. A primary home may instead qualify for the Section 121 exclusion, which can exclude up to $250,000 of gain for a single filer or $500,000 for a married couple. A property used partly for rental and partly as a residence can involve both rules on different portions.
What happens if I take some cash out of the exchange?
Cash taken out is boot and becomes taxable up to the amount of your realized gain. The rest of the gain stays deferred. Taking $50,000 out of a deal with $300,000 of realized gain means $50,000 is recognized now and $250,000 is deferred. Boot can also trigger depreciation recapture and the 3.8% net investment income tax on the recognized portion.
What kinds of property count as like-kind?
For real estate, the like-kind standard is broad. Almost any U.S. real property held for investment or business use is like kind to almost any other, so land, rental homes, commercial buildings, and industrial property can be exchanged interchangeably. What does not qualify is property outside the U.S., a personal residence, inventory held for sale, and, since 2018, all personal property.
Do I still have to reduce my basis after the exchange?
Yes. The replacement property takes a carryover basis rather than a stepped-up one, so it is usually lower than the purchase price by the amount of deferred gain. That lower basis reduces the depreciation you can claim each year on the new property and preserves the deferred gain, which is recognized when you eventually sell without exchanging again.
Reviewed by The Ledgerism Editorial Team. Last reviewed: July 2026.