Common Questions
Your 1031 Exchange Questions, Answered
If you have a question about 1031 exchanges, the answer is probably here. If not — just ask us.
This FAQ is for general informational purposes. It does not constitute legal or tax advice. Consult a qualified tax advisor for your specific situation.
Basics
Any U.S. taxpayer — individual, partnership, LLC, corporation, or trust — who holds real property for investment or productive use in a trade or business may qualify. Key requirement: investment or business use only. Primary residences and dealer property do not qualify. If you own a rental property, raw land, or commercial real estate, you likely qualify. Contact Prospect Exchange to confirm.
A 1031 exchange (named after IRC Section 1031) lets real estate investors defer federal capital gains taxes when they sell one investment property and reinvest the proceeds into a like-kind replacement property. Instead of paying the IRS at closing, you roll your equity forward into your next investment. The tax is deferred — not eliminated — but deferral compounds over a lifetime of exchanges and can be permanently erased when heirs receive a stepped-up basis at death. Most U.S. investment real estate qualifies.
No minimum value is required by the IRS. However, a 1031 exchange only makes financial sense when the tax savings exceed the cost and complexity of the exchange. For most investors, that threshold is roughly $100,000 or more in equity — but every situation is different. Prospect Exchange can help you evaluate whether an exchange is worth it for your transaction. Contact us for a no-obligation review.
Possibly — but with careful planning. A vacation home used primarily for personal enjoyment does not qualify as investment property. However, if the property has been rented to unrelated parties at fair market rent for at least 14 days per year and your personal use does not exceed 14 days or 10% of the rental days, it may qualify under IRS Revenue Procedure 2008-16. The key is establishing investment intent through documented rental history. Consult your tax advisor before proceeding.
Timeline Rules
Absolute. You have exactly 45 calendar days from the closing of your relinquished property to deliver a signed, written identification of your replacement property to your Qualified Intermediary. Weekends do not extend it. Holidays do not extend it. There are no IRS-granted extensions. If you miss day 45, your exchange is disqualified and all proceeds become taxable. Prospect Exchange tracks this deadline and sends reminders, but the responsibility is yours. Contact us before you list your property — not the day of closing.
You have 180 calendar days from the closing of your relinquished property to close on your replacement property. However, this deadline is also capped by your tax return due date — whichever comes first. For individual filers who sell between approximately October 18 and December 31, April 15 arrives before day 180. Filing IRS Form 4868 before April 15 restores your full 180-day window. Prospect Exchange tracks both deadlines and alerts you in advance.
If you close on your relinquished property late in the year (roughly October 18 to December 31), your April 15 federal tax return deadline arrives before your 180th day. The IRS uses whichever deadline comes first as your effective exchange deadline — so late-year sellers can lose weeks of exchange time without realizing it. The fix is straightforward: file IRS Form 4868 before April 15 to extend your return to October 15. That extension does not affect your tax payment due date — only your filing deadline and exchange window. File the extension as a precaution even if you do not normally need one.
Your exchange is disqualified. All sale proceeds in your exchange account become immediately taxable as capital gains in the year of the relinquished property sale — federal depreciation recapture, long-term capital gains, NIIT (if applicable), and Utah state tax. There is no partial credit and no late-start provision. This is why having a dedicated Qualified Intermediary tracking your deadlines matters. If you believe you might miss a deadline, call us immediately — in rare cases, IRS-declared disaster relief extends deadlines.
Identification Rules
The Three-Property Rule allows you to identify up to three replacement properties of any value. You do not need to acquire all three — you can identify three and ultimately close on one. This is the most commonly used identification method because it is the most flexible and easiest to apply. Most investors identify their top two or three candidates and proceed with the best option that closes in time.
The 200% Rule allows you to identify more than three replacement properties, as long as their combined fair market value does not exceed 200% of the relinquished property's sale price. This is useful when you want to spread your equity across multiple smaller properties or are uncertain which of several properties you will be able to close on. If you are exchanging a $500,000 property, you could identify any number of properties as long as their combined value stays under $1,000,000.
The 95% Rule allows you to identify any number of properties of any total value, as long as you actually acquire at least 95% of the combined fair market value of everything you identified. This rule is rarely used in practice because the acquisition threshold is extremely high — identify $2 million in property, and you must close on at least $1.9 million of it. Most investors use the Three-Property Rule instead. The 95% Rule is primarily useful for large portfolios with very specific acquisition plans.
QI Role
IRS regulations (IRC Section 1031 and Treasury Regulation Section 1.1031(k)-1) prohibit you from having "actual or constructive receipt" of the sale proceeds during the exchange. If you touch the money — even briefly — the exchange is disqualified. A Qualified Intermediary holds the funds in a segregated account between your sale and your replacement property purchase, ensuring you never have constructive receipt. The QI is not optional; it is the legal foundation of every valid 1031 exchange.
Before you list your property. Ideally, before you sign a purchase and sale agreement. The QI must prepare an Exchange Agreement and Assignment Agreement before your relinquished property closes — not after. If you wait until closing day, it is too late. Prospect Exchange recommends contacting us as soon as you have a general timeline for your sale, even if closing is months away. Early coordination gives you the most options.
Key factors: (1) Segregated exchange accounts — your funds should never be commingled with operating funds or other clients funds. (2) Fidelity bond coverage — protects against employee dishonesty and fraud. (3) Errors and omissions insurance — covers professional liability. (4) Local presence — a QI who knows your market and title companies reduces friction. (5) Responsiveness — 1031 exchanges have hard deadlines; your QI needs to be reachable. Prospect Exchange maintains segregated accounts, carries fidelity bond and E&O coverage, and is based in Pleasant Grove. Contact us for details on our coverage.
Prospect Exchange quotes fees per transaction — pricing depends on the type and complexity of the exchange. A standard Forward Exchange is simpler and less expensive than a Reverse or Improvement Exchange. Contact us for a quote specific to your transaction. There is no cost for an initial consultation.
Tax Concepts
Boot is any non-like-kind property or cash you receive during the exchange. Common forms of boot: (1) Cash boot — if you do not reinvest all net proceeds, the leftover cash is boot. (2) Mortgage relief boot — if your replacement property has less debt than your relinquished property and you do not compensate with additional cash, the difference is boot. Boot is taxable in the year of the exchange. To defer all capital gains, you must reinvest all net equity and acquire a replacement property of equal or greater value with equal or greater debt. Receiving some boot is sometimes intentional — you pay tax only on the boot amount, not the full gain.
Depreciation recapture (IRC Section 1250) is the IRS way of taxing back the depreciation deductions you claimed on the property over the years. When you sell, the portion of your gain equal to accumulated depreciation is taxed at a flat 25% federal rate — not the lower long-term capital gains rate. A 1031 exchange defers both the regular capital gains tax and the depreciation recapture tax. However, the accumulated depreciation carries forward into your replacement property adjusted basis, so the eventual tax does not disappear — it is deferred until you sell without exchanging.
The 3.8% Net Investment Income Tax (NIIT) applies to net investment income — including capital gains from real estate — for taxpayers above certain income thresholds ($200,000 single / $250,000 married filing jointly). A 1031 exchange defers the NIIT on the deferred gain, just as it defers the regular capital gains tax. If you receive boot, the NIIT may apply to the recognized boot gain. Consult your tax advisor for your specific MAGI and NIIT exposure.
Eligibility
Like-kind does not mean the same type of property — it means both properties must be held for investment or productive use in a trade or business. Under this broad definition, you can exchange a single-family rental for commercial property, raw land for an apartment building, or industrial property for a retail strip center. What does not qualify: your primary residence, property held primarily for sale (dealer property), personal property (since the 2017 Tax Cuts and Jobs Act), and foreign property exchanged for U.S. property.
Yes. A 1031 exchange can cross state lines — you can sell Utah property and replace it with property in Nevada, Idaho, Arizona, or any other U.S. state. The like-kind requirement applies to the nature of the property (investment use), not its location. Note that some states have their own capital gains or clawback provisions for out-of-state exchanges; consult a tax advisor familiar with both the relinquished and replacement property states.
Exchanging with a related party (family member, controlled entity) requires extra caution. If you sell your relinquished property to a related party, or if the related party disposes of the acquired property within two years, the exchange may be disqualified. Buying your replacement property from an unrelated party is generally straightforward. Buying from a related party may be permissible if neither party disposes of the property within two years. This area of the law is complex — always consult a tax attorney before proceeding with a related-party exchange.
Strategy
Yes. You can exchange one relinquished property for multiple replacement properties, as long as your identification is valid (Three-Property Rule, 200% Rule, or 95% Rule) and you reinvest all net proceeds across the acquisitions. You can also exchange multiple relinquished properties into one replacement property, or multiple into multiple. This flexibility makes 1031 exchanges useful for consolidating or diversifying a portfolio. Each combination has its own nuances — contact us to discuss your specific structure.
Yes, with careful planning. After a 1031 exchange, you must hold the replacement property as investment property for a qualifying period (IRS guidance suggests at least two years). After that, you may convert it to your primary residence and potentially qualify for the Section 121 exclusion ($250,000 single / $500,000 married filing jointly) when you eventually sell. However, the deferred 1031 gain and post-2009 non-qualified use periods affect how much of the Section 121 exclusion you can claim. This is a sophisticated planning strategy — work with a CPA before executing it.
Your heirs receive a stepped-up basis equal to the fair market value of the property at the date of your death (IRC Section 1014). This permanently eliminates the deferred capital gain accumulated across your lifetime of exchanges. The entire deferred tax obligation disappears — no capital gains, no depreciation recapture, no NIIT. This is one of the most powerful long-term benefits of a 1031 exchange strategy: compound tax deferral over a lifetime, followed by a permanent step-up for your heirs. Estate tax may still apply depending on the total estate value.
Exchange Types
A Reverse Exchange lets you acquire your replacement property before you sell your relinquished property. Because you cannot hold both properties simultaneously during the exchange period, an Exchange Accommodation Titleholder (EAT) — a special-purpose entity — holds title to one of the properties until the other side of the transaction completes. The same 45-day and 180-day deadlines apply from the date the EAT acquires the parked property. Reverse exchanges are more complex and more expensive than standard Forward Exchanges. They are best suited for competitive markets where you find your replacement property before your current property sells.
Yes — through an Improvement Exchange (also called a Build-to-Suit or Construction Exchange). An Improvement Exchange allows you to direct your exchange funds toward improvements on the replacement property as part of the exchange, effectively using pre-tax dollars to renovate or build. An EAT holds title to the replacement property during the improvement phase. All improvements must be completed and the enhanced property must be transferred to you within the 180-day exchange period. This structure is useful for investors buying a property requiring significant renovation or builders structuring a 1031 into new construction.
A Simultaneous Exchange is when the relinquished property and replacement property close on the same day. This was the original structure before the Starker case established the Delayed Exchange in 1979. Simultaneous exchanges are rare today because they require nearly perfect coordination between both closings — any timing mismatch can disqualify the exchange. Most investors use the Delayed Exchange structure instead. If you are considering a simultaneous structure, contact us early to coordinate the documentation and timing.
Reporting
You report a 1031 exchange on IRS Form 8824 ("Like-Kind Exchanges"), filed with your federal income tax return for the year in which the relinquished property closed. If the exchange is not complete by your tax return filing date (including extensions), you still report the disposition of the relinquished property that year and complete the exchange reporting the following year. Your Qualified Intermediary provides documentation to help your tax preparer complete Form 8824. Prospect Exchange provides a summary of all exchange transactions and fund movements for your records.
Glossary
1031 Exchange Glossary
Plain-language definitions for the terms you will encounter most.
This content is for general informational purposes only and does not constitute legal or tax advice. Consult a qualified tax advisor for your specific situation.
- Adjusted Basis
- The original cost of the property plus capital improvements, minus accumulated depreciation. Adjusted basis is used to calculate realized gain at sale and carries forward into the replacement property after a 1031 exchange.
- Assignment Agreement
- A document that assigns the seller's rights in the purchase and sale agreement to the Qualified Intermediary, allowing the QI to act as the party receiving the exchange proceeds.
- Boot
- Any non-like-kind property or cash received in a 1031 exchange. Boot is taxable in the year of the exchange. Common forms include cash proceeds not reinvested and mortgage relief (net reduction in debt between relinquished and replacement properties).
- Build-to-Suit Exchange
- Also called an Improvement Exchange or Construction Exchange. A 1031 exchange structure that allows the exchanger to use exchange funds for improvements to the replacement property, effectively spending pre-tax dollars on construction or renovation. An EAT holds title during the improvement phase.
- Capital Improvements
- Permanent improvements that increase the value, extend the life, or adapt a property to a new use. Capital improvements are added to the property's adjusted basis (increasing it and reducing the gain at sale) and are distinct from ordinary repairs and maintenance.
- Constructive Receipt
- A legal concept under which the IRS treats a taxpayer as having received funds even if they have not physically touched the money — for example, when the funds are set aside for their use or held by their agent. In a 1031 exchange, constructive receipt of proceeds disqualifies the exchange. The Qualified Intermediary structure prevents constructive receipt.
- Delayed Exchange
- The most common 1031 exchange structure, also called a Forward Exchange. The exchanger sells the relinquished property, parks the proceeds with a Qualified Intermediary, identifies a replacement property within 45 days, and closes on it within 180 days.
- Depreciation Recapture
- The portion of a capital gain equal to accumulated depreciation that is taxed at a flat 25% federal rate under IRC Section 1250 when investment property is sold. A 1031 exchange defers depreciation recapture along with the regular capital gains tax.
- Exchange Accommodation Titleholder (EAT)
- A special-purpose entity that holds title to a property during a Reverse Exchange or Improvement Exchange. The EAT is used because the exchanger cannot simultaneously own both the relinquished and replacement properties during the exchange period.
- Exchange Agreement
- The master contract between the exchanger and the Qualified Intermediary establishing the 1031 exchange relationship, the QI's responsibilities, and the terms under which exchange funds are held and disbursed.
- Exchange Period
- The 180-calendar-day window from the closing of the relinquished property during which the exchanger must close on the replacement property. The exchange period is also capped by the exchanger's tax return due date, whichever comes first.
- Form 8824
- IRS form used to report a like-kind exchange. Filed with the federal income tax return for the year in which the relinquished property closed. Shows the property exchanged, the property received, any boot, and the gain deferred.
- Identification Deadline
- The 45-calendar-day deadline from the closing of the relinquished property by which the exchanger must deliver a signed, written identification of up to three (or more, under alternative rules) replacement properties to the Qualified Intermediary. Absolute — no extensions.
- Identification Period
- The first 45 calendar days of the 1031 exchange, during which the exchanger must formally identify replacement property candidates in writing. The identification period runs concurrently with the 180-day exchange period.
- Improvement Exchange
- See Build-to-Suit Exchange. A structure allowing exchange funds to be used for property improvements during the exchange period, with an EAT holding title until the improvements are complete.
- IRC Section 1031
- The Internal Revenue Code section governing like-kind exchanges of real property held for productive use in a trade or business or for investment. Since the Tax Cuts and Jobs Act of 2017, Section 1031 applies only to real property.
- Like-Kind Property
- Real estate held for investment or for use in a trade or business, exchanged for other U.S. real estate of the same nature. Almost any investment or business real property is like-kind to another — an apartment building is like-kind to raw land or a strip mall. A primary residence or property held mainly for resale does not qualify.
- Long-Term Capital Gain
- Gain from the sale of an asset held for more than one year. Long-term capital gains are taxed at preferential federal rates (0%, 15%, or 20% depending on income) rather than ordinary income rates. Most 1031 exchange gains qualify as long-term capital gains plus depreciation recapture.
- Mortgage Relief (Debt Relief Boot)
- The taxable boot created when the replacement property carries less debt than the relinquished property and the exchanger does not compensate with additional cash. For example, if you sell a property with $300,000 in debt and buy a replacement with $200,000 in debt without adding $100,000 cash, the $100,000 difference is mortgage relief boot.
- Net Investment Income Tax (NIIT)
- A 3.8% surtax on net investment income (including capital gains from real estate) for taxpayers above MAGI thresholds: $200,000 single / $250,000 married filing jointly / $125,000 married filing separately. A 1031 exchange defers the NIIT on the deferred gain.
- Notice to Buyer/Seller
- A required document notifying the other party in each transaction (both the buyer of the relinquished property and the seller of the replacement property) that the QI has been assigned the exchanger's rights in the purchase and sale agreement.
- Qualified Intermediary (QI)
- The independent party required by IRS regulations to hold exchange proceeds between the sale of the relinquished property and the purchase of the replacement property. The QI prepares documentation, holds funds in segregated accounts, and coordinates with title and escrow. A Qualified Intermediary cannot be the exchanger, the exchanger's agent, or a related party.
- Realized Gain
- The total gain on sale, calculated as net sale proceeds (sale price minus selling costs) minus adjusted basis. Realized gain is the starting point for calculating tax exposure. A 1031 exchange defers the recognized portion of the realized gain.
- Relinquished Property
- The property being sold in a 1031 exchange. Also called the "downleg" property. The exchange clock starts on the day the relinquished property closes.
- Replacement Property
- The like-kind property acquired in a 1031 exchange. Also called the "upleg" property. Must be identified within 45 days and closed within 180 days of the relinquished property closing.
- Reverse Exchange
- A 1031 exchange structure in which the exchanger acquires the replacement property before selling the relinquished property. Because the exchanger cannot hold both properties simultaneously, an EAT holds one property during the exchange period. The same 45-day and 180-day deadlines apply.
- Segregated Exchange Account
- A dedicated account maintained by the Qualified Intermediary exclusively for one exchanger's exchange funds. IRS safe-harbor regulations require that exchange funds not be commingled with the QI's operating funds or other clients' funds. Segregated accounts protect the exchanger in the event of QI insolvency.
- Forward Exchange (Delayed Exchange)
- The most common 1031 exchange structure: sell your relinquished property, park the proceeds with a Qualified Intermediary, identify a replacement property within 45 days, and close within 180 days. Historically called a Starker Exchange after the 1979 Ninth Circuit case Starker v. United States.
- Stepped-Up Basis
- Under IRC Section 1014, heirs who inherit property receive a tax basis equal to the fair market value of the property at the date of the owner's death, regardless of the decedent's original basis. For 1031 exchange investors, this means the entire lifetime of deferred capital gains — including depreciation recapture — is permanently eliminated at death.
- Tax-Deferred Exchange
- See 1031 Exchange. The term "tax-deferred" emphasizes that the capital gains tax is postponed — not eliminated — unless the property is held until death (stepped-up basis) or the exchange is unwound in a later sale.
- 200% Rule
- An identification method allowing the exchanger to identify more than three replacement properties, as long as their combined fair market value does not exceed 200% of the relinquished property's sale price.
- 95% Rule
- An identification method allowing the exchanger to identify any number of properties at any total value, as long as the exchanger ultimately acquires at least 95% of the combined fair market value of all identified properties.
- 45-Day Identification Period
- The first 45 calendar days of a 1031 exchange, during which the exchanger must formally identify replacement property candidates in a signed written notice delivered to the Qualified Intermediary. The deadline is absolute — no extensions for weekends, holidays, or any other reason.
- 180-Day Exchange Period
- The full window during which the exchanger must close on the replacement property — measured from the closing of the relinquished property. Capped by the exchanger's tax return due date (including extensions) if that date arrives before day 180.
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