1031 Exchange Options: What Are They?

A Section 1031 exchange allows owners of business and investment property to postpone paying capital gains tax on the sale of a property by reinvesting the proceeds into a new one. Governed by the Internal Revenue Code, the core concept involves swapping one qualifying property for another of a “like-kind,” continuing the original investment. The tax code provides several options for how these transactions can be structured. There are also multiple ways to hold title to the replacement property, offering choices between direct management and passive ownership.

Core Requirements and Timelines for Any Exchange

The “like-kind” property rule is central to any exchange. For real estate, this standard is interpreted broadly, focusing on the property’s nature or character, not its grade or quality. This means an investor can exchange improved real estate for unimproved land, a commercial building for a residential rental property, or a ranch for an apartment complex. Both properties must be held for business or investment use within the United States.

A valid exchange requires using a Qualified Intermediary (QI), an independent third party who facilitates the transaction. The QI holds the sales proceeds from the relinquished property, which prevents the exchanger from having actual or constructive receipt of the funds and triggering a taxable event. The QI prepares exchange documents, oversees the transfer of funds, and helps ensure the transaction adheres to all regulatory requirements. An exchanger’s agent, such as their attorney or accountant, is prohibited from acting as the QI.

The timelines for an exchange are strict. The first is the 45-day identification period, which begins the day after the relinquished property sale closes. Within this window, the exchanger must identify potential replacement properties in a signed written document delivered to the QI, including the property’s address or legal description. The second deadline is the 180-day exchange period, during which the exchanger must acquire the replacement property. This 180-day period runs concurrently with the 45-day window, and these deadlines are not extended, except in cases of federally declared disasters.

Exchangers must also understand “boot.” Boot is any non-like-kind property received during an exchange, such as cash, a reduction in mortgage debt, or personal property. To defer all capital gains tax, the exchanger must reinvest all equity and acquire a replacement property of equal or greater value. Any boot received is a taxable gain reported for the tax year in which it is received.

Transactional Exchange Structures

The most common method is the delayed exchange. The process begins when an investor sells their relinquished property, and the sales proceeds are sent directly to a Qualified Intermediary. From the date of this sale, the investor must adhere to the 45-day identification and 180-day exchange periods to acquire a replacement property. The QI facilitates the final purchase by wiring the held funds to the closing agent.

A reverse exchange is used when an investor must acquire a new property before selling their existing one, which is common in competitive markets. Since an investor cannot hold title to both properties, a specialized third party called an Exchange Accommodation Titleholder (EAT) is required. Per IRS Revenue Procedure 2000-37, the EAT acquires and “parks” the title to the replacement property. The 45-day and 180-day timelines begin from the date the EAT takes title, during which the investor must identify and sell their relinquished property to complete the exchange.

An improvement or construction exchange allows an investor to use tax-deferred funds to acquire a property and pay for renovations or new construction. This process also requires an Exchange Accommodation Titleholder to take title to the property while improvements are made. Exchange proceeds are used for the initial purchase, with remaining funds disbursed by the QI to pay for construction. For the exchange to be fully tax-deferred, the final value of the improved property must be equal to or greater than the value of the relinquished property. All construction must be completed within the 180-day exchange window.

Replacement Property Ownership Options

For investors seeking a passive role, the Delaware Statutory Trust (DST) is an ownership option. A DST is a legal entity holding income-producing properties, allowing multiple investors to buy a beneficial interest. Per IRS Revenue Ruling 2004-86, an interest in a DST is considered “like-kind” to real property and is eligible for an exchange. Investors pool their funds to acquire fractional ownership in large assets, such as apartment complexes or medical offices. A professional sponsor company handles all property management, providing investors with potential income without landlord duties.

A Tenants in Common (TIC) arrangement is another fractional ownership option. In a TIC structure, up to 35 investors co-own a property, with each holding a separate deed for their share, providing direct property ownership. IRS Revenue Procedure 2002-22 provides guidelines for structuring TICs to qualify for an exchange. This direct ownership gives investors more control over property decisions than a DST, but it also comes with greater responsibility. This structure is suited for investors who desire control over their asset but wish to pool their capital to acquire a larger property than they could afford alone.

Completing and Reporting Your Exchange

The first step in any exchange is to engage a Qualified Intermediary before the relinquished property sale closes. The relationship is formalized by signing an Exchange Agreement, a legally binding document that outlines the duties of both the exchanger and the QI. This agreement is a prerequisite for a valid exchange, as it establishes the framework that prevents the exchanger from having constructive receipt of the funds.

After the exchange is complete, the transaction must be reported to the IRS on Form 8824, “Like-Kind Exchanges.” This form is filed with the taxpayer’s federal income tax return for the year the exchange was initiated. The purpose of the form is to provide a detailed account of the exchange to justify the tax deferral. It is used to calculate the realized gain and the recognized gain, which is the taxable portion from any boot received. The form also determines the new adjusted basis of the replacement property for future tax calculations.