1031 exchange

Also called like-kind exchange

A swap of one investment or business real estate property for another that lets the owner defer capital gains tax on the sale.

What it means

Under Section 1031 of the tax code, real property held for business or investment can be exchanged for other like-kind real property without paying tax on the gain at that time. Like-kind is broad for real estate: a rental house can be exchanged for an apartment building or land. Personal residences do not qualify, and since 2018 the rule covers only real property, not equipment or vehicles.

Strict rules apply. A qualified intermediary generally holds the sale proceeds, replacement properties must be identified within 45 days of the sale and the purchase must close within 180 days (or by the tax return due date, if that comes sooner). Cash or debt relief taken out, called boot, is taxable. The old basis carries into the new property, so the gain is deferred, not erased, although a step-up in basis at death can remove it.

Example

Suppose an investor sells a rental with a $300,000 basis for $500,000, a $200,000 gain, ignoring depreciation for simplicity. They reinvest all proceeds plus $50,000 more in a $550,000 property; the gain is deferred, and the new basis is $350,000.

How it’s used

Trading up to a larger rental property
Changing locations or property types
Long-term real estate investing

Strengths and weaknesses

Strengths

Defers capital gains and depreciation recapture tax
Keeps more money working in real estate
Can be repeated over many years

Weaknesses

Tight deadlines and paperwork
Intermediary and transaction costs
Gain is deferred, not eliminated
Not available for a primary home

Good to know

Exchange rules are technical; mistakes can make the whole gain taxable, so many investors use specialists.

Educational information only, not financial, tax or legal advice. Rules, limits and rates change; check the IRS, your lender or plan, or a qualified professional before acting.