Short answer
Section 1031 of the Internal Revenue Code says that you recognize no gain when you exchange real property held for investment or business for other real property of a like kind that you will also hold for investment or business. In practice that lets a real estate investor sell one property, buy another, and defer the capital gains tax. This guide walks through what each part of 26 U.S.C. §1031 says and how it applies to a real estate exchange.
| Subsection | What it covers | Why it matters to you |
|---|---|---|
| (a)(1) | The general rule | No gain recognized on a like-kind exchange of real property |
| (a)(2) | Exception | Real property held primarily for sale is excluded |
| (a)(3) | Deferred exchanges | The 45-day and 180-day deadlines |
| (b) | Gain from exchanges not solely in kind | Cash or other "boot" is taxable |
| (d) | Basis | Your old basis carries into the new property |
| (f) | Related persons | Two-year holding rule for exchanges with family or your companies |
| (h) | Foreign property | U.S. and foreign real estate are not like-kind |
On this page
- 01The general rule: subsection (a)(1)
- 02The exception: subsection (a)(2)
- 03Deferred exchanges and the deadlines: subsection (a)(3)
- 04Boot: subsections (b) and (c)
- 05Basis: subsection (d)
- 06Related persons: subsections (f) and (g)
- 07Foreign property: subsection (h)
- 08What the statute does not say
- 09Frequently asked questions
- 10Sources
The general rule: subsection (a)(1)
The core sentence says no gain or loss is recognized on the exchange of real property held for productive use in a trade or business or for investment, if it is exchanged solely for real property of a like kind to be held the same way. Three conditions sit inside that sentence:
- Real property. Since the Tax Cuts and Jobs Act, the section covers only real property. Before 2018 it also covered equipment, vehicles and other personal property. The regulations define real property as land, buildings, other inherently permanent structures and certain interests in land (Treas. Reg. §1.1031(a)-3).
- Held for business or investment, both before and after. A rental, an office you use in your business, or land held for appreciation qualifies. Your home does not.
- Like kind. This refers to the nature of the property, not its quality. Improved and unimproved real estate are like-kind to each other (Treas. Reg. §1.1031(a)-1(b)), so a duplex can be exchanged for a strip center or farmland.
Note the word "loss": a 1031 exchange also defers losses, which is why investors selling at a loss usually do not use one.
The exception: subsection (a)(2)
Real property held primarily for sale is excluded. That covers fix-and-flip houses and lots a developer subdivides and sells to customers. Whether you are an investor or a dealer depends on facts such as how often you sell, how long you hold, and whether you improve property to resell it. If you build to sell, a 1031 exchange is usually not available for that inventory.
Deferred exchanges and the deadlines: subsection (a)(3)
Few exchanges are simultaneous swaps. Subsection (a)(3) allows a delayed exchange, but property you receive is not treated as like-kind unless you:
- identify it within 45 days after transferring your property, and
- receive it by the earlier of 180 days after the transfer or the due date (with extensions) of your tax return for that year.
The regulations add the details: how to identify, the 3-property and 200% limits, and the qualified intermediary safe harbor that keeps you from receiving the cash (Treas. Reg. §1.1031(k)-1). See the 45-day rule and the 1031 timeline.
Boot: subsections (b) and (c)
If you receive cash or other property that is not like-kind along with the new real estate, the exchange still works, but gain is recognized up to the value of that extra "boot". Debt relief counts: if your new mortgage is smaller than the one paid off, the difference is treated like cash unless you add your own money (Treas. Reg. §1.1031(d)-2). Subsection (c) adds that a loss is still not recognized when boot is received.
Example. You sell for $900,000 with a $600,000 gain and buy a $850,000 replacement, keeping $50,000 in cash. You recognize $50,000 of gain and defer $550,000. See how boot is taxed and the partial exchange boot calculator.
Basis: subsection (d)
The deferred gain does not disappear. Your new property generally takes the basis of the old one, increased by any gain you recognized and any extra cash you paid, and decreased by any cash you received. In the example above, if the old property's basis was $300,000, the new property's basis would be about $300,000. That lower basis means smaller depreciation deductions and a larger taxable gain if you later sell for cash. See what happens to depreciation in a 1031 exchange.
Related persons: subsections (f) and (g)
If you exchange with a related person, such as a parent, child, sibling or a company you control, and either of you disposes of the property within two years, the deferred gain becomes taxable at that point. Subsection (f)(4) blocks arrangements designed to get around this, such as using an intermediary to buy from a relative who then keeps the cash. Subsection (g) pauses the two-year clock while your risk of loss is reduced. See related party rules.
Foreign property: subsection (h)
Real property in the United States and real property outside the United States are not like-kind. You can exchange foreign property for other foreign property, but not a U.S. rental for a villa abroad. See can you 1031 exchange into foreign property?
What the statute does not say
Several common "rules" are not in Section 1031 itself:
- A minimum holding period. There is none in the statute, apart from the 2-year related-party rule. Intent and use decide whether property was held for investment.
- The requirement to use a qualified intermediary. The QI is a safe harbor in the regulations, not a statutory requirement, but in a delayed exchange it is the practical way to avoid receiving the money.
- "Equal or greater value." That is the condition for deferring all the tax, not for qualifying. See equal or greater value.
- DSTs and reverse exchanges. These come from IRS rulings: Rev. Rul. 2004-86 for Delaware statutory trusts and Rev. Proc. 2000-37 for reverse exchanges.
For the practical checklist built on all of this, see the 1031 exchange rules guide. For the step-by-step process, see how a 1031 exchange works.
Frequently asked questions
Can an LLC do a 1031 exchange?
Yes. An LLC can sell and buy in its own name. A single-member LLC that is disregarded for tax is treated as its owner, so the owner can sell personally and buy through that LLC. A multi-member LLC is the taxpayer itself, so its members cannot exchange their shares separately.
Can I do a 1031 exchange on property outside the U.S.?
Only for other foreign property. Section 1031(h) says U.S. and foreign real property are not like-kind.
Does Section 1031 apply to my home?
No. Your main home is personal-use property. Gain on a home sale may qualify for the separate exclusion in IRC §121 instead.
Sources
- 26 U.S.C. §1031 (full text of the statute)
- Treas. Reg. §1.1031(a)-1 (like-kind and held for investment)
- Treas. Reg. §1.1031(a)-3 (definition of real property)
- Treas. Reg. §1.1031(k)-1 (deferred exchanges)
- Treas. Reg. §1.1031(d)-2 (assumed liabilities)
- Rev. Rul. 2004-86 (Delaware statutory trusts)
- Rev. Proc. 2000-37 (reverse exchanges)
This article is general information, not tax or legal advice. Talk to your CPA or tax attorney about your situation.
