What Is A 1031 (Like-Kind) Exchange?

Written by

Keeper Expert

Krislyn Chan

Updated

March 4, 2026

Peer reviewed by

a tax professional

You've built equity in an investment property. Maybe it's a rental duplex you've held for a decade, or a small commercial building that has finally appreciated nicely. You want to sell, but you've done the math and the capital gains tax bill looks painful. That's where the 1031 like-kind exchange comes in. Named after Section 1031 of the Internal Revenue Code, this provision allows real estate investors to defer capital gains taxes on the sale of an investment property, as long as the proceeds are reinvested into a "like-kind" replacement property. This guide breaks down how a 1031 exchange works, including the important tax implications your CPA would want you to know.

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What is a 1031 like-kind exchange?

A 1031 exchange, sometimes called a "like-kind exchange", lets you sell a qualifying investment property and reinvest the proceeds into another qualifying property without recognizing capital gains in the year of the sale.

But let's be clear: the gain is deferred, not forgiven. The tax obligation follows you into the replacement property. When you eventually sell that property without doing another exchange, you'll owe taxes on the accumulated deferred gains. That said, many investors chain multiple 1031 exchanges over their lifetime and pass property to heirs with a stepped-up basis (in plain english, the IRS "resets" the cost basis of that property to its fair market value on the date of your death), thus potentially eliminating the deferred tax altogether.

Without a stepped-up basis, imagine this:

You bought a property for $200,000 (your original basis)
You did three 1031 exchanges over 30 years, deferring gains the whole time
The property is now worth $2,000,000
Your carried-over basis is still somewhere around $200,000 (or lower, after depreciation)
If you sold it, you'd owe capital gains tax on roughly $1.8M of gain

With a stepped-up basis at death, your heir inherits that $2,000,000 property with a new basis of $2,000,000 - the current market value. If they turned around and sold it the next day for $2,000,000, they'd owe zero capital gains tax. All those decades of deferred gains are permanently wiped out, not just deferred. So the best move it to defer, defer, defer throughout your investing life, and then death itself permanently eliminates what you deferred.

What qualifies as a like-kind property?

Since the Tax Cuts and Jobs Act of 2017, Section 1031 applies exclusively to real property held for business use or investment.

What qualifies:

Rental properties (residential)
Commercial real estate
Vacant investment land
Industrial or warehouse space
Mixed-use investment buildings

What doesn't qualify:

Your primary residence
Vacation homes used personally
Property held primarily for sale (ex: a fix and flip)
Foreign property
Stocks, bonds, or personal property

Keeper pro tip: One frequently misunderstood point: "like-kind" is much broader than most people assume. The IRS defines it by the nature of the asset, not its quality or type. You can exchange a rental house for a commercial warehouse, or raw land for an apartment complex as long as both are held for investment or business purposes.

Timeline matters

The IRS imposes two hard deadlines that run concurrently, meaning the clock for both starts the moment you close on the sale of your original property (the "relinquished property").‍

45-Day Identification Rule: You have 45 calendar days to formally identify potential replacement properties in writing.

‍180-Day Closing Rule: You must close on the replacement property within 180 calendar days of the sale, or by your tax return due date including extensions, whichever comes first. Note that the 180 days include the first 45, not in addition to them.

You also have three ways to identify properties within those 45 days:

Three-Property Rule: Identify up to three properties, regardless of their total value.
200% Rule: Identify more than three, as long as their combined fair market value doesn't exceed 200% of what you sold.
95% Rule: Identify any number of properties, but you must actually acquire at least 95% of their combined identified value.

The most important rule: don't touch the money

From the moment you sell the relinquished property, the proceeds must flow through a Qualified Intermediary (QI): an independent third party who holds the funds and uses them to acquire the replacement property on your behalf.

If the proceeds ever hit your bank account, the exchange is disqualified and the full gain becomes immediately taxable. The IRS calls this "constructive receipt," and it's a strict rule with no room for forgiveness.

QI fees typically run between $600 and $1,200, with additional fees for complex or multi-property exchanges. Choose your intermediary carefully! Unlike bank deposits, QI-held funds are generally not FDIC-insured, and there have been cases of QI fraud. Make sure to verify their reputation, bonding, and experience.

Tax implications

Capital gains tax: Deferred

The primary benefit of a 1031 exchange is deferral of long-term capital gains tax. Depending on your income, that rate is 0%, 15%, or 20% federally. The 3.8% Net Investment Income Tax (NIIT) also applies to high earners and is similarly deferred. State capital gains taxes vary and may also be deferred, depending on your state.

Depreciation recapture: Deferred

When you own rental or investment property, the IRS lets you deduct depreciation over time - typically 27.5 years for residential property. When you sell, the IRS "recaptures" those deductions and taxes them at up to 25% (Section 1250 recapture).

A properly structured 1031 exchange defers depreciation recapture, but only if you reinvest all the proceeds, replace or exceed your existing debt level, and acquire replacement property that is also depreciable. If you exchange a rental home for vacant land, for example, recapture may become immediately taxable because undeveloped land cannot be depreciated.

The "boot" problem

"Boot" is anything you receive in the exchange that isn't like-kind property: cash, debt relief, or personal property. It's immediately taxable. Two kinds of "boot" commonly catch investors off guard:

Cash Boot: If you walk away with any cash from the proceeds, that amount is taxable in the year of the exchange.
Mortgage Boot (Debt Relief Boot): If your replacement property has a smaller mortgage than the property you sold, the reduction in debt is treated as taxable boot. For example, if you sold a property with a $400,000 mortgage and bought one with only a $300,000 mortgage, the IRS treats that $100,000 difference as boot.

To completely avoid boot, you need to:

Reinvest all net equity
Buy replacement property of equal or greater value
Replace your existing debt with equal or greater debt on the new property

Bonus depreciation

With the One Big Beautiful Bill making 100% bonus depreciation permanent for qualified property starting in 2025, real estate investors who have aggressively used cost segregation studies face a newer complexity.

If your relinquished property contained significant Section 1245 personal property components (fixtures, HVAC systems, or equipment that was separately depreciated via cost segregation), those components must be replaced by equivalent Section 1245 property on the replacement side. If they aren't (say, you're trading a commercial building with lots of equipment for vacant land), recapture of that bonus depreciation can trigger ordinary income taxes at rates up to 37%, even if the exchange is otherwise structurally perfect.

If you've done cost segregation work on your property, make sure your CPA runs a pre-exchange analysis! Need help? Book a call with a Keeper CPA!

Reporting a 1031 exchange: IRS Form 8824

Every 1031 exchange must be reported on Form 8824 (Like-Kind Exchanges) attached to your federal tax return for the year the exchange was initiated. The form captures the sale price, basis, gain recognized, gain deferred, and basis in the replacement property.

If you file with software like TurboTax, be aware that the interview process is not designed for 1031 complexity. For any exchange involving boot, cost segregation, multiple properties, or cross-year timing, it's best to work with a CPA or tax attorney is strongly recommended. Keeper is built to handle tax complexity by design. Need help? Give us a try!

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3 more tax strategies worth knowing

Reverse 1031 Exchange

‍Picture this. ‍You've found your replacement property first, before selling your current one. This happens more often than you'd expect. In a standard exchange, you have to sell your current property before buying another. A reverse exchange solves this by having an Exchange Accommodation Titleholder (EAT) take title to the new property and hold it on your behalf while you sell the relinquished property. You still have 180 days to complete the sale, and the same IRS rules apply!

However, note that reverse exchanges are more expensive, and can require $3,000-$5,000 in QI and legal fees.

Delaware Statutory Trusts (DSTs)

‍A popular tool for investors who want to exit active management of their property, but aren't ready to pay the tax bill.

Say you've owned a 10-unit apartment building for 15 years. You're done dealing with tenants and maintenance calls, but selling outright would trigger a substantial capital gains and depreciation recapture bill. A DST lets you exchange your property into a fractional ownership interest in a professionally managed portfolio without taking on any operational responsibilities. The IRS has ruled that DST interests qualify as like-kind property, so the exchange is fully valid.

The catch: DST investments are illiquid. You typically can't sell your fractional interest on demand, and your control over the asset is minimal by design. They're best suited for investors in or near retirement who prioritize passive income over flexibility.

Opportunity Zone Stacking

Sometimes boot is unavoidable. Maybe the deal math doesn't work perfectly, or you need some liquidity. If that's you, consider directing the taxable boot into a Qualified Opportunity Fund (QOF) within 180 days of the sale. The gain on the boot portion gets deferred, and if you hold the QOF investment for at least 10 years, any appreciation on that portion becomes permanently tax-free.

Importantly, the One Big Beautiful Bill (signed July 2025) extended and enhanced Opportunity Zone benefits, including a new permanent exclusion for long-term QOF holders, making this pairing more attractive than it was even a year ago. Not every investor will qualify or want the illiquidity, but for the right situation it effectively layers two deferral mechanisms on top of each other.

If boot is unavoidable, consider reinvesting that taxable portion into a Qualified Opportunity Fund (QOF) to further defer or reduce the tax on the boot portion.

Defer, Defer, Defer Indefinitely

The idea is straightforward: rather than ever selling and triggering a tax event, you do a 1031 exchange every time you want to upgrade or reposition your portfolio. Each exchange carries the deferred gain forward. Done over a 20–30 year investing career, you might defer millions in capital gains.

Then, when property passes to your heirs at death, the IRS resets the cost basis to the fair market value on the date of death: the stepped-up basis. Your heirs could sell the property the next day and owe nothing on the gain you spent a lifetime deferring. The deferred tax isn't just postponed; it disappears.

The risk: current stepped-up basis rules under IRC §1014 could change. There have been recurring legislative proposals to limit or eliminate it, and while the rule remains intact now, investors who are building their entire estate plan around this outcome should stress-test the strategy with their CPA and estate attorney against potential future law changes.