Section 1031 is the reason real estate dynasties exist. Swap one investment property for another following the rules, and capital gains tax, depreciation recapture, and (usually) state tax are all deferred — letting 100% of your equity keep compounding. Repeat for life and the stepped-up basis at death can erase the deferred gain permanently. Investors call it 'swap till you drop.'
The rules, however, are unforgiving. Here is what you must know before you sell.
What Taxes Does a 1031 Defer?
A properly executed exchange defers federal capital gains (15–20%), depreciation recapture (up to 25%), the 3.8% net investment income tax, and state income tax — in California, up to 13.3%. On a $400,000 gain with $150,000 of accumulated depreciation, an exchange can keep well over $200,000 working for you instead of Washington and Sacramento.
The Non-Negotiable Rules
Miss any of these and the exchange fails — usually with no fix available:
- Qualified Intermediary (QI) engaged BEFORE closing — touch the proceeds and the exchange is dead
- 45 days from sale closing to identify replacement property in writing
- 180 days from sale closing to close on the replacement
- Like-kind: any U.S. real property held for investment qualifies (rental for land, duplex for retail — all fine)
- Equal or greater value, and all equity reinvested, to defer 100%
- Same taxpayer on both sides of the exchange
Understanding 'Boot' (Partial Exchanges)
Take any cash out, or buy a cheaper replacement, and the difference — 'boot' — is taxable in the exchange year. Debt relief counts too: replace a $300K mortgage with a $200K one and you have $100K of mortgage boot unless you add cash. Partial exchanges are legal and sometimes smart; they just need to be modeled, not discovered in April.
Identification Strategy: The 45-Day Game
The 45-day window is where exchanges die. You may identify up to three properties regardless of value (the three-property rule) or more under the 200% rule. Serious exchangers go under contract on replacements before closing the sale, use backup identifications, and sometimes negotiate longer escrows on the downleg to extend the effective search period. Map the dates with the free 1031 exchange deadline calculator.
When NOT to Exchange
A 1031 is a deferral tool, not a religion. Skipping the exchange can be smarter when:
- Suspended passive losses will absorb most of the gain anyway — check before paying QI fees
- You are in an unusually low-income year and can harvest gain at 0–15%
- The gain is small relative to transaction costs and replacement risk
- You want liquidity and an installment sale better fits your goals
- Estate plans already position heirs for a near-term step-up
Exit Ramps: DSTs and the Step-Up
Tired landlords can exchange into Delaware Statutory Trusts (DSTs) — fractional institutional properties that satisfy 1031 rules with zero management. And the endgame remains the stepped-up basis: heirs inherit at fair market value, erasing decades of deferred gain and recapture. That is why exchange planning belongs inside a broader tax plan, not a panicked escrow call.
Thinking about selling? Model the exchange-vs-sale decision with our real estate tax team before you list — every option disappears at closing.
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Explore the serviceFrequently Asked Questions
Can I 1031 exchange into a property I'll eventually live in?
Carefully. The replacement must be held for investment first — safe-harbor practice is renting it at fair market value for at least two years before any conversion. Move in immediately and you invite the IRS to unwind the exchange.
Does a 1031 exchange work for fix-and-flips?
Generally no. Flips are inventory held for sale, not investment property, so they fail the held-for-investment requirement. Flippers reduce tax through entity structure and timing instead — see our S corp strategies.
What happens to my old depreciation after an exchange?
Your basis carries over: the replacement inherits the old property's remaining basis plus any new money. You keep depreciating the carryover basis on its original schedule and the new increment fresh — and recapture stays deferred until a taxable sale.
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About the author
Samera Harvey, EA — Enrolled Agent & Founder
Samera Harvey is an IRS Enrolled Agent and the founder of Simply Smart Tax Advisors. She began her career in public accounting serving high-net-worth families, multi-state entities, and corporate tax structures — then built her own real estate investment companies, renovated and resold hundreds of properties, and educated more than 2,000 aspiring investors. She founded Simply Smart Tax Advisors to help entrepreneurs build tax strategy alongside wealth, not after it.
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