A 1031 exchange, also known as a like-kind exchange or tax-deferred exchange, is where real property that is "held for productive use in a trade or business or investment" is sold and the proceeds from the sale are reinvested into a like-kind property intended for business or investment use — allowing the taxpayer to defer the capital gains tax and depreciation recapture on the transaction.

A 1031 exchange is one of the most powerful wealth-building tools available to real estate investors — allowing capital to compound tax-deferred across multiple transactions.

Relinquished Property & Replacement Property

The property sold as part of a 1031 exchange is the Relinquished Property. The property purchased is the Replacement Property. The real property in a 1031 exchange must be like-kind; most real estate is like-kind to all other real estate.

Like-Kind Exchange Examples

  • An office building exchanged for a rental duplex
  • A retail shopping center exchanged for farmland
  • Raw land exchanged for an apartment complex
  • A single-family rental exchanged for a commercial warehouse

The Critical Role of the Qualified Intermediary

During a 1031 exchange, neither the taxpayer nor an agent of the taxpayer can receive or control the funds from the sale of the property. If a taxpayer has direct or indirect access to the funds, a 1031 exchange is no longer valid. A Qualified Intermediary (QI) is used to hold the proceeds of the Relinquished Property sale until it is time to transfer those proceeds for the close of the Replacement Property.

Who Is Eligible?

To be eligible for a 1031 exchange, the person or entity must be a US tax-paying identity. This includes individuals, partnerships, S-corporations, C-corporations, LLCs, and trusts. However, it is a requirement that the same taxpayer who sells the relinquished property also purchases the replacement property for a valid exchange.

A Brief History

1031 exchanges were first authorized in 1921 because Congress recognized the importance of people reinvesting in business assets — and they wanted to encourage more of it. There have been changes and additions to the regulations governing 1031 exchanges, with the most recent changes impacting real estate occurring in 2001.

Today, 1031 exchanges remain one of the most powerful wealth-building strategies available to real estate investors, used by individuals and institutions alike to grow their portfolios without the immediate drag of capital gains taxation.