What Is a 1031 Exchange? An Educational Overview

Understanding the Purpose of a 1031 Exchange

A 1031 exchange is a tax-deferral strategy available to real estate investors under Section 1031 of the U.S. Internal Revenue Code. It may allow an investor to sell an investment property and reinvest the proceeds into another qualifying property without immediately recognizing capital gains tax.

Rather than eliminating taxes, a 1031 exchange defers them by carrying the original cost basis forward into the replacement property. This approach can help investors keep more capital invested and may support long-term portfolio planning when executed properly.

The Concept of Tax Deferral

A key distinction of a 1031 exchange is that it is not tax avoidance. The deferred capital gains tax obligation remains embedded in the replacement property and may become due when the property is eventually sold without a subsequent exchange.

The rationale behind this structure is that the investor continues to hold real estate for investment or business purposes, rather than converting the asset into cash for personal use. As long as this continuity is maintained and IRS requirements are followed, the tax obligation may be deferred.

Like-Kind Property Explained

The term like-kind does not require properties to be identical. For real estate, the IRS applies a broad definition. Most real property held for investment or business use is considered like-kind to other real property held for the same purpose.

Examples of Potentially Like-Kind Exchanges

• An apartment building exchanged for raw land

• A single-family rental exchanged for a retail property

• A commercial property exchanged for a Delaware Statutory Trust (DST) interest

What matters is the nature of the investment, not the quality or specific use.

Investment or Business Use Requirement

Both the relinquished property and the replacement property must be held for investment or productive use in a trade or business. Properties held primarily for personal use—such as a primary residence or vacation home—generally do not qualify.

The IRS evaluates intent based on facts and circumstances, including how the property is used before and after the exchange.

Required Timelines in a 1031 Exchange

A successful exchange depends on meeting two strict deadlines that begin when the original property is sold.

The 45-Day Identification Period

Within 45 calendar days of closing the sale, the investor must formally identify potential replacement properties in writing to a Qualified Intermediary.

Common identification rules include:

• Three-Property Rule: Identify up to three properties regardless of value

• 200% Rule: Identify multiple properties as long as total value does not exceed 200% of the relinquished property’s value

The 180-Day Exchange Period

The purchase of the replacement property must be completed within 180 calendar days of selling the original property. This 180-day window includes the initial 45-day identification period.

Missing either deadline generally disqualifies the exchange.

The Role of a Qualified Intermediary (QI)

A Qualified Intermediary is a neutral third party required to facilitate the exchange. The investor cannot take possession of the sale proceeds at any point.

Responsibilities of a QI

• Holding exchange proceeds in a segregated account

• Receiving written property identifications

• Transferring funds to complete the replacement property purchase

• Preparing exchange documentation

Using a QI is mandatory for maintaining compliance with IRS regulations.

Equal or Greater Value Requirement

To fully defer capital gains tax, the replacement property must:

• Be equal to or greater in value than the relinquished property

• Reinvest all net equity from the sale

• Replace any debt paid off on the relinquished property

If these conditions are not met, partial taxation—often referred to as boot—may occur.

Variations of 1031 Exchanges

While delayed exchanges are most common, other structures exist.

Reverse Exchange

Allows acquisition of a replacement property before selling the original property. Because the investor cannot own both simultaneously, a special-purpose entity temporarily holds title.

Improvement (Construction) Exchange

Permits exchange funds to be used for improvements on the replacement property, provided construction is completed within the exchange period and value requirements are met.

These variations involve additional complexity and typically require advanced planning.

Planning Considerations

A 1031 exchange requires careful coordination and documentation.

Key considerations include:

• Confirming investment intent

• Evaluating long-term portfolio objectives

• Coordinating with tax, legal, and real estate professionals

• Preparing well in advance of property sale

Because the rules are rigid, small missteps may result in loss of tax deferral.

Conclusion

A 1031 exchange is a structured tax-deferral strategy that may support long-term real estate investment planning when executed correctly. By reinvesting proceeds into qualifying properties and adhering to IRS rules, investors may preserve capital and maintain portfolio continuity.

As with any advanced tax strategy, determining suitability depends on individual circumstances, goals, and professional guidance.

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Investment advice offered through Stratos Wealth Partners, Ltd., a registered investment advisor. Stratos Wealth Partners, Ltd and Parkview Partners Capital Management are separate entities. Neither Stratos nor Parkview Partners Capital Management provides legal or tax advice. Please consult legal or tax professionals for specific information regarding your individual situation. Investing involves risk, including possible loss of principal. The information presented is for educational purposes only and should not be interpreted as individualized investment, tax, or legal advice. Past performance is not indicative of future results. For more information, please review our Form ADV, available upon request.