A 1031 exchange, sometimes referred to as a “like-kind exchange,”1 can be a useful tax planning strategy to defer capital gains tax on the sale of a business or investment real property to future years by using the proceeds on the sale to buy a similar type of property.
While 1031 exchanges can be complex and there are many factors to consider when structuring your exchange, the following simple steps below can help outline the typical 1031 exchange process:
- Identify the business property to sell.
- Identify the business property to purchase.
- Remember, the replacement property must be “like-kind” (meaning of the same nature, character, or class as the property being sold).
- Choose a qualified intermediary.
- A qualified intermediary or “exchange facilitator” is essential in helping to ensure that the funds are held in escrow until the exchange is complete. If the proceeds are received prematurely, then this could trigger a gain on sale.
- Decide how much of the sale proceeds will go toward the replacement property.
- An individual does not have to reinvest the total proceeds received from the sale of the property. However, any portion of the proceeds kept and not re-invested will result in capital gains and tax owed.
- Consider treatment of debt relief.
- When selling a property with outstanding debt, it is crucial to understand if the old debt is not replaced with equal or greater new debt, or by adding outside cash to avoid taxation, then the debt relief is considered taxable “boot” and taxed as a capital gain.
- The IRS views the reduction in mortgage as receiving cash, even if no cash physically changes hands.
- Be sure that deadlines are met. Two deadlines must be met to have a qualifying exchange:
- 45 days from the date of sale to identify potential replacement properties. The potential properties must be identified in writing and shared with the seller or qualified intermediary.
- 180 days from the date of sale or by the due date of your tax return (including extensions; whichever is earlier) to purchase the identified replacement property.
Noting the above, there are multiple types of 1031 exchanges possible. They include:
- Simultaneous exchange
- Deferred exchange (delayed exchange)
- Reverse exchange
- Improvement exchange
Each exchange has nuanced, particular rules that can be quite complex. Regardless of the exchange chosen, understanding 1031 steps can be a useful strategy for managing real estate investment taxes.
For more information or if you are interested in learning about these different exchange types, please reach out to a real estate consulting services professional at Forvis Mazars.
- 1“Like-kind exchanges – Real estate tax tips,” irs.gov, May 1, 2025.