Quick Take: 1031 exchanges offer powerful tax-deferral benefits for real estate investors, but common misconceptions can lead to costly mistakes. Contrary to popular belief, these exchanges aren’t limited to the ultra-wealthy or commercial properties—any investment or business-use real estate can qualify. But misunderstandings around timing, reinvestment rules and the use of a qualified intermediary can trigger taxes or even disqualify an exchange. By understanding the answers to these key questions, investors can fully leverage this valuable wealth-building strategy.
1031 exchanges are a powerful tool for real estate investors, but common misinterpretations can lead to costly mistakes, forgone opportunities and even IRS penalties. Many investors enter the process with incorrect assumptions about the requirements and tax implications of a 1031 exchange. Here are 10 common misconceptions that can help any investor save time and money by understanding what is and what isn’t allowed under the 1031 law—and maximize the program’s tax-deferral benefits.
Aren’t 1031 exchanges just a tax loophole for the ultra-wealthy? Isn’t this something only large investors can use?
Not at all. While many high-net-worth individuals do take advantage of 1031 exchanges, the provision is available to any taxpayer holding property for investment or business use, regardless of the property’s value. The ultra-wealthy focus on tax planning, and smaller investors can and should look to do the same.
I’ve heard “like-kind” means I have to exchange my property for something almost identical. Is that really the case?
No, the term “like-kind” is much broader than most realize. It refers more to the nature or character of the property. Almost any investment or business-use property can be exchanged for another—so you could swap a rental condo for raw land, or an office building for a shopping center. The applicability is far greater than the phrase suggests. But you must ensure that you’ve held the property for a reasonable length of time. Although there is no statutory minimum, properties held for short periods (like fix-and-flip homes) generally do not qualify for a 1031 exchange.
I thought only commercial properties qualify for 1031 exchanges. Are residential rentals eligible?
Yes, they are. Any property held for investment or productive use in a trade or business can qualify—including residential rentals, co-ops, health care facilities and undeveloped land. The key is that the property is not your primary residence, vacation home or property held primarily for resale. Also, only real property qualifies for a 1031 exchange; personal property such as equipment or vehicles do not.
Isn’t it true that I have to find someone to swap properties with me directly, and the exchange has to happen at the same time?
This is a common misconception. 1031 exchanges can be “delayed exchanges.” This means that you must simply execute a sale of your property to one party and purchase a replacement from another within the timelines set out by the IRS. Direct, simultaneous swaps are not required. For more information on the timeline read our 1031 exchange checklist. Hints: You do not want to miss your 45-day identification window. And you will want to identify a qualified intermediary before you sell your asset.
If I do a 1031 exchange, doesn’t that mean I’ll never have to pay taxes on the gain?
1031 exchanges defer taxes; they do not eliminate them. When you eventually sell the replacement property without doing another exchange, the deferred gain becomes taxable. However, if you continue exchanging, you can defer taxes indefinitely. In some cases, your heirs may benefit from a step-up in basis.
I only need to reinvest the profit or the cash I receive from the sale to qualify for a 1031 exchange, right?
To fully defer taxes, you must reinvest all net proceeds from the sale and acquire property of equal or greater value. If you only reinvest the gain or a portion of the proceeds, the amount not reinvested (known as “boot”) will be subject to capital gains tax. We recommend having your CPA run the numbers before closing.
I have a mortgage on my relinquished property (the property I’m selling). Do I have to take on the exact same amount of debt on the replacement property (the property I’m buying)?
No, you do not have to match the debt exactly. You can replace debt with additional cash or other financing. The important thing is that the total value and equity in the new property are equal to or greater than what you gave up.
If I don’t reinvest every single dollar from the sale, do I lose all the tax benefits of the exchange?
Not entirely. Partial exchanges are allowed. If you take some cash out, only that portion is taxable. The portion that you reinvest remains tax deferred. For example, I purchase a property for $300,000 and net $480,000 from my sale but only want to reinvest $400,000 into a 1031 exchange. I will defer $100,000 of my capital gains that I reinvest. But I will have to pay capital gains taxes on the $80,000 I did not use in the 1031 exchange.
Can’t I just deal with the 1031 exchange after I close on the property and receive my cash?
No. The IRS deadlines are strict. Starting from your closing date, you have 45 days to identify a replacement property and 180 days to close. (See timeline above.) There are no extensions for most circumstances. Missing these deadlines will disqualify your exchange. So will receiving the sale proceeds yourself. Make sure you use a qualified intermediary, or your exchange will be null and void. For more information on this topic, read our article on 1031 exchanges.
My attorney or CPA has handled my real estate deals for years. Can’t they just serve as my qualified intermediary for the exchange?
Unfortunately, no. The IRS prohibits anyone who has represented you in the past two years—including your attorney, CPA or real estate agent—from serving as your qualified intermediary. You must use a truly independent third party to facilitate the exchange.
1031 exchanges have bipartisan support and remain to be an impactful wealth building tool. But careful planning, knowledge and guidance are essential to avoid unexpected taxes or disqualified exchanges. If you have questions about your exchange, or are interested in learning more about evaluating private real estate investments and how Origin Investments delivers long-term value, schedule a call with our investor relations team.
