1031 Exchange
A tax-deferral strategy allowing real estate investors to defer capital gains by reinvesting sale proceeds into a like-kind property.
What is 1031 Exchange?
A 1031 exchange (named after Section 1031 of the Internal Revenue Code) allows real estate investors to defer paying capital gains taxes on the sale of an investment property by reinvesting the proceeds into a 'like-kind' replacement property. The rules require: the replacement property must be of equal or greater value; proceeds must be held by a qualified intermediary (not the seller); the investor must identify replacement property within 45 days of the sale; and the exchange must be completed within 180 days. 1031 exchanges are available only for investment or business properties — not primary residences. The deferred gain rolls into the new property's basis, eventually taxed when that property is sold (unless another 1031 exchange is used).
Example
An investor sells a rental property for $800,000, with a cost basis of $300,000 and a taxable gain of $500,000. Rather than paying $100,000+ in capital gains taxes, they execute a 1031 exchange and purchase two smaller rental properties for a combined $850,000. The $500,000 gain is deferred indefinitely. The strategy is sometimes repeated multiple times, with heirs eventually receiving a stepped-up basis at death, potentially eliminating the deferred gain permanently.