The 1031 Exchange Timeline, and the Rules That Break It

Section 1031 lets you sell real property held for investment or business use and reinvest into replacement property without recognizing the gain immediately. It is one of the most useful provisions available to a property owner and one of the easiest to forfeit, because almost every way it fails is a timing or a custody problem rather than a disagreement about the tax.

The two clocks

Both start on the day you transfer the relinquished property, and they run at the same time — the 180 days is not 45 plus 180.

The identification rules

You cannot simply write down every property you might want. Identification must be unambiguous — a street address or legal description — and it has to fit one of three tests:

• The three-property rule: identify up to three properties, at any value.
• The 200 percent rule: identify any number of properties, as long as their combined fair market value does not exceed 200 percent of the value of what you sold.
• The 95 percent rule: identify any number of properties of any value, but you must actually acquire at least 95 percent of the value identified.

Most exchanges use the three-property rule, and most experienced investors identify a backup precisely because the 45 days cannot be extended.

You cannot touch the money

This is the requirement that most often destroys an exchange before it starts. If you receive the sale proceeds — or have the right to receive them — you have constructive receipt, the exchange fails, and the gain is taxable. Money passing briefly through your account is not a technicality that can be cleaned up afterward.

A qualified intermediary must hold the funds, and must be engaged before the relinquished property closes. It cannot be your CPA, your attorney or your real estate agent if they have acted for you in the last two years, and it cannot be a relative. Choosing a QI is a due-diligence decision: they will hold your money, and they are not federally regulated the way a bank is.

What qualifies now

Since the 2017 tax law, Section 1031 applies to real property only. Exchanges of equipment, vehicles, machinery, artwork and other personal property no longer qualify. Older guidance still circulating online predates that change.

Both properties must be held for productive use in a trade or business or for investment. Property held primarily for resale — a flip — does not qualify. Your primary residence does not qualify, though a different provision may apply to it.

The taxpayer who sold must be the taxpayer who buys. If the relinquished property was held by an LLC, the replacement generally needs to be acquired by that same LLC. Partnership situations where some partners want to exchange and others want cash need planning well ahead of the sale.

Boot, and partial deferral

An exchange does not have to be all or nothing, but anything you take out is taxable. Cash you receive, debt relief that is not replaced with new debt, and non-like-kind property are all "boot" and are taxable to the extent of your gain.

As a general rule, to defer the full gain you need to reinvest all the net proceeds and carry at least as much debt on the replacement property as you had on the property you sold.

Deferred is not forgiven

A 1031 exchange defers tax; it does not eliminate it. Your basis carries over into the replacement property, which means a lower basis, less depreciation going forward, and a larger gain on an eventual taxable sale. Depreciation recapture rides along with it.

That is not an argument against exchanging — deferral has real value, and the deferred position can change again under later planning. It is an argument for knowing what you are carrying forward rather than treating the exchange as the end of the matter.

The order that works

• Decide you intend to exchange before you list the property, not after you have an offer.
• Engage a qualified intermediary before closing on the sale.
• Include exchange cooperation language in the sale contract.
• Start looking at replacement property immediately — 45 days is short.
• Identify in writing, unambiguously, before day 45, with a backup.
• Watch the return due date if the sale is late in the year, and extend if needed.
• Report the exchange on Form 8824 with the return for the year of the sale.