A Step-by-Step Guide to Completing a 1031 ExchangeJanuary 4, 2026

A 1031 exchange is one of the most powerful tax-deferral strategies available to real estate investors. When executed correctly, it allows you to sell an investment property and reinvest the proceeds into another property while deferring capital gains taxes. When executed incorrectly, however, it can result in a failed exchange and a significant, unexpected tax bill.

Because the IRS enforces strict rules and deadlines, completing a 1031 exchange requires careful planning, precise timing, and proper documentation. This guide walks through the entire process step by step, explaining exactly what needs to happen at each stage so investors can move forward with confidence.

Understanding the Basics Before You Start

Before beginning a 1031 exchange, it is critical to understand what qualifies, how the process works, and whether this strategy aligns with your investment goals.

What Is a 1031 Exchange?

A 1031 exchange refers to Section 1031 of the Internal Revenue Code, which allows investors to defer capital gains taxes when selling real estate held for investment or business use. The deferral occurs when the proceeds from the sale are reinvested into another like-kind property.

Like-kind does not mean identical. It simply means both properties must be real estate used for investment or business purposes. Residential rental properties, commercial buildings, industrial properties, and vacant land can all qualify as like-kind to one another.

It is important to understand that a 1031 exchange defers taxes rather than eliminating them. The tax liability carries forward into the replacement property unless the investor continues exchanging or the property receives a step-up in basis upon death.

Who Qualifies for a 1031 Exchange

To qualify, the property being sold and the replacement property must be held for investment or business use. Primary residences, second homes used primarily for personal purposes, and fix-and-flip properties generally do not qualify.

The ownership entity must also remain consistent. The same taxpayer who sells the relinquished property must acquire the replacement property. An individual cannot sell personally and then purchase under an LLC unless specific ownership requirements are met.

When a 1031 Exchange Makes Sense

A 1031 exchange is most effective for long-term investors who plan to stay invested in real estate. It is particularly beneficial when capital gains are significant, when investors want to upgrade properties, or when portfolio growth and tax efficiency are priorities. It may be less suitable for investors seeking liquidity or those exiting real estate entirely.

Step 1: Pre-Exchange Planning

Successful 1031 exchanges begin long before a property is listed for sale. Planning early reduces risk and increases the likelihood of completing a compliant exchange.

Assessing Your Investment Goals

Before selling, investors should clearly define what they want from the replacement property. This may include higher cash flow, appreciation potential, geographic diversification, or reduced management responsibilities. Understanding these goals helps guide property selection and prevents rushed decisions later in the process.

Estimating Capital Gains and Tax Exposure

Calculating potential capital gains is essential. This includes determining the adjusted basis of the property, accounting for improvements and depreciation. Understanding how much tax is being deferred helps investors evaluate whether a 1031 exchange provides meaningful benefits relative to its costs.

Assembling Your Professional Team

A qualified intermediary is required for any 1031 exchange. This intermediary holds the sale proceeds and facilitates the exchange according to IRS rules. In addition, investors should work with a CPA, tax advisor, and real estate professional who understand 1031 exchanges. Engaging these professionals early helps prevent errors that could disqualify the exchange.

Step 2: Selling the Relinquished Property

Once planning is complete, the next step is selling the property that will be exchanged.

Listing and Selling Your Property

Timing matters. Investors should coordinate the sale with exchange planning to ensure replacement properties are available within the required deadlines. The purchase agreement should include language indicating the seller’s intent to complete a 1031 exchange.

Engaging a Qualified Intermediary

A qualified intermediary must be engaged before the sale closes. If sale proceeds are paid directly to the investor, even temporarily, the exchange will be disqualified. The intermediary prepares exchange documents and ensures funds are handled correctly.

Transfer of Sale Proceeds

At closing, sale proceeds are transferred directly to the qualified intermediary. The investor does not have access to these funds during the exchange period. This safeguard is critical to maintaining compliance with IRS regulations.

Step 3: Identifying Replacement Properties (45-Day Rule)

Once the relinquished property is sold, the clock begins ticking.

Understanding the 45-Day Identification Deadline

Investors have 45 calendar days from the date of sale to identify potential replacement properties. This deadline is strict and cannot be extended except in rare disaster-related circumstances.

Identification Rules

The IRS allows three identification methods. The three-property rule allows investors to identify up to three properties regardless of value. The 200 percent rule allows identification of more properties as long as their total value does not exceed 200 percent of the sold property’s value. The 95 percent exception allows identification of any number of properties if at least 95 percent of their value is ultimately acquired.

How to Choose the Right Replacement Property

Due diligence during this period is critical. Investors should evaluate financial performance, location, condition, and long-term viability. Selecting a property solely to meet deadlines without proper analysis can undermine the benefits of the exchange.

Step 4: Purchasing the Replacement Property (180-Day Rule)

After identification, the exchange must be completed within the allowed timeframe.

Understanding the 180-Day Completion Deadline

The investor has 180 days from the sale of the relinquished property to close on the replacement property. This timeframe includes the initial 45-day identification period.

Closing on the Replacement Property

The qualified intermediary coordinates the transfer of funds at closing. Title to the replacement property must be taken by the same taxpayer who sold the relinquished property. Lenders, attorneys, and the intermediary must work together to ensure proper execution.

Equal or Greater Value and Debt Requirements

To fully defer taxes, the replacement property must be equal or greater in value, and all sale proceeds must be reinvested. Additionally, any debt paid off on the relinquished property must be replaced with equal or greater debt on the new property, unless additional cash is contributed.

Step 5: Avoiding Taxable Boot

Boot refers to any non-like-kind property or cash received during the exchange and is taxable.

What Is Boot in a 1031 Exchange?

Cash boot occurs when an investor receives leftover cash after purchasing the replacement property. Mortgage boot occurs when the new property has less debt than the relinquished property and the difference is not offset with cash.

Common Causes of Boot

Boot often results from purchasing a lower-value property, failing to reinvest all proceeds, or improperly structuring debt. Even small amounts of boot can trigger partial tax liability.

How to Structure the Exchange to Minimize Boot

Careful planning helps avoid boot. Investors should aim to purchase properties of equal or greater value, reinvest all proceeds, and replace debt appropriately. Contributing additional cash when needed can preserve full tax deferral.

Step 6: Special Types of 1031 Exchanges

Some exchanges require alternative structures to meet investment needs.

Delayed Exchanges

This is the most common type of exchange, where the property is sold first and replaced later within the 45-day and 180-day deadlines.

Reverse Exchanges

In a reverse exchange, the replacement property is purchased before selling the relinquished property. This structure is complex but useful in competitive markets where desirable properties must be secured quickly.

Construction or Improvement Exchanges

This exchange allows proceeds to be used to improve the replacement property before the exchange is completed. All improvements must be finished within the 180-day window.

Delaware Statutory Trusts

DSTs allow investors to own fractional interests in institutional-grade real estate and qualify for 1031 exchanges. This option appeals to investors seeking passive ownership and diversification.

Step 7: Reporting the 1031 Exchange to the IRS

Completing the exchange does not end the process.

IRS Form 8824

The exchange must be reported on IRS Form 8824 with the tax return for the year the sale occurred. This form details the properties involved, timelines, and deferred gain.

Working With Your Tax Professional

Accurate reporting is essential. Errors on Form 8824 can raise red flags or delay processing. A qualified tax professional ensures documentation aligns with IRS requirements.

Common Mistakes That Can Disqualify a 1031 Exchange

Several mistakes can invalidate an exchange. Missing deadlines, taking possession of funds, failing to use a qualified intermediary, purchasing non-like-kind property, or violating ownership rules can all result in immediate taxation. Proper planning and professional guidance significantly reduce these risks.

When a 1031 Exchange May Not Be the Right Choice

A 1031 exchange may not be ideal if immediate liquidity is needed, if capital gains are minimal, or if the investor plans to leave real estate investing altogether. Market conditions may also make it difficult to find suitable replacement properties within required timelines.

Frequently Asked Questions

How long does a 1031 exchange take from start to finish?
The full process can take several months. Planning often begins before the sale, followed by up to 180 days after closing to complete the exchange.

Can I do a partial 1031 exchange?
Yes. Investors may reinvest only part of the proceeds, but any cash or non-like-kind property received will be taxable.

Can I live in a property acquired through a 1031 exchange?
The property must initially be held for investment. Converting it to a primary residence is possible later but subject to holding period and IRS rules.

Is there a limit on how many properties I can identify?
Yes. Identification limits depend on the rule used, such as the three-property rule or the 200 percent rule.

What happens if my replacement property deal falls through?
If no replacement property is acquired within 180 days, the exchange fails and the sale becomes taxable.

Conclusion

Completing a 1031 exchange successfully requires careful attention to detail, strict adherence to deadlines, and coordination among experienced professionals. When done correctly, it preserves capital, defers taxes, and allows investors to grow and reposition their real estate portfolios efficiently.

By understanding each step and planning ahead, investors can use the 1031 exchange as a long-term strategy to build wealth, improve cash flow, and create lasting financial security through real estate.