What is a 1031 Commercial Exchange in Real Estate?

Key Takeaways

• A 1031 exchange enables investors to defer capital gains taxes by reinvesting proceeds from the sale of an investment property into a like-kind replacement property.
• Under current IRS rules, only real property qualifies; personal property, intangible assets, and foreign real estate are excluded.
• Investors must adhere to strict timelines, including 45 days to identify potential replacement properties and 180 days to complete the transaction.
• A qualified intermediary (QI) is required to facilitate the exchange, and disqualified parties, such as a CPA or attorney, cannot serve in this role.
• Receiving boot—such as cash, debt relief, or non-qualifying property—creates a taxable event within the exchange.

Commercial real estate investment is inherently complex, particularly when navigating detailed processes and transaction structures. For many investors, portfolio growth is central to long-term success. Achieving this growth often involves strategic opportunities to buy, sell, and exchange commercial real estate assets. When an investor plans to sell one property and acquire another for investment or business purposes, a 1031 exchange may be the optimal strategy.

The term “1031 exchange” originates from Section 1031 of the Internal Revenue Code (IRC), which states: “No gain or loss shall be recognized on the exchange of real property held for productive use in a trade or business or for investment if such real property is exchanged solely for real property of like-kind, which is to be held either for productive use in a trade or business or for investment.”

In practice, a 1031 exchange enables investors to transition from one property to another while deferring capital gains taxes, allowing more equity to be reinvested. To qualify for these tax benefits, exchanges must follow strict parameters, rules, and timelines established by the IRS.

Because 1031 exchanges provide tax deferral, enhance cash flow, and support long-term portfolio expansion, they remain a widely used strategy among commercial real estate investors. This guide will outline the mechanics of a 1031 exchange, key requirements, and what investors should expect throughout the process.

What is a Property Exchange?

A property exchange is the transfer of one investment or business-use property for another of similar classification. To qualify for capital gains tax deferral, the IRS requires that the properties be considered like-kind. When structured properly, there is no limit to how many times—or how frequently—an investor can complete 1031 exchanges.

What is a 1031 Exchange and How Does it Work?

A 1031 exchange is a real estate transaction that allows investors to defer capital gains taxes by reinvesting proceeds from the sale of an investment property into another like-kind property within specific timeframes. 

For example, if an investor sells a commercial property for a $500,000 gain and faces a 20 percent capital gains tax rate, the tax liability would be $100,000. By completing a 1031 exchange, the investor can reinvest the full $500,000 into another qualifying property of equal or greater value, deferring the tax obligation. While the concept is straightforward, investors must follow strict IRS rules to ensure the exchange remains valid and the tax benefits are preserved.

How Do 1031 Exchanges Work?

To complete a 1031 exchange, investors must follow specific steps and adhere to strict deadlines. Missing a requirement or failing to comply with IRS rules may result in full capital gains taxes becoming due. This is why partnering with an experienced professional is essential for navigating the process. Below are the five key steps to completing a compliant 1031 exchange:

Step 1: Engage a Qualified Intermediary

Exchange proceeds are taxable if received directly by the investor, so funds must be handled by a Qualified Intermediary (QI). Taking possession of sale proceeds—even temporarily—can disqualify the transaction and trigger immediate taxation. A QI serves as the neutral third party, holding funds until the purchase of the replacement property is complete. The IRS also restricts who can serve as a QI: disqualified persons include your CPA, attorney, real estate agent, or anyone with whom you have had a close personal or business relationship in the past two years. These restrictions ensure the exchange is conducted objectively and in compliance with IRS guidelines.

Step 2: Sell the Relinquished Property

Once a QI is in place, the investor may proceed with the sale of the current property. Because the timeline to secure a replacement property is limited, investors should be prepared to act quickly after the sale closes. All funds from the transaction must be directed to the QI—not the investor.

Step 3: Identify a Replacement Property Within 45 Days

Investors have 45 days from the sale of the relinquished property to identify potential replacement properties—without exception or extension. Properties must be like-kind, held for investment or business purposes, and not for personal use. Identification must be made in writing, signed, and delivered to the QI or another party involved in the exchange.

Step 4: Close on the Replacement Property Within 180 Days

The replacement property must be purchased and closed within 180 days of selling the original asset. Proceeds held by the QI are then applied to the acquisition, completing the exchange.

Step 5: File IRS Form 8824

Investors must file IRS Form 8824 to report the like-kind exchange. Working with a real estate advisor and tax professional helps ensure all reporting requirements are met accurately and on time.

Understanding “Boot” in a 1031 Exchange

If an investor receives anything other than like-kind property during a 1031 exchange, it is considered “boot” and becomes taxable. Boot can take several forms, including:

• Cash proceeds are retained instead of reinvested.
• Mortgage relief, when the debt on the replacement property is less than the debt paid off on the relinquished property.
• Non-qualifying property, such as furniture, equipment, or other personal assets included in the transaction.

Receiving boot does not invalidate the exchange, but the value of the boot is taxed as a capital gain. With careful planning and structuring, advisors can often help minimize—or in some cases eliminate—the impact of boot.

What Property Qualifies For a 1031 Exchange?

A 1031 exchange must be conducted between properties the IRS defines as like-kind. This means both the relinquished and replacement properties must be held for business or investment purposes—though they do not have to be identical in type. For example, an investor selling a convenience store is not required to purchase another convenience store; any qualifying investment property may serve as the replacement.

The IRS rules allow broad flexibility in property type, as long as the use is business or investment-related. Eligible properties may be located anywhere in the United States, without restrictions by city or state. An investor could sell an East Coast asset and reinvest in the West, and the exchange would still qualify.

Multiple properties may also be included in a single exchange. For instance, an investor can sell one property and acquire three, provided all are held for business or investment use.

Replacement properties must be of equal or greater value than the relinquished property to maintain full tax deferral. If the replacement property is valued lower, the difference becomes taxable as boot.

What Properties Don’t Qualify

Not every asset type qualifies under Section 1031. The Tax Cuts and Jobs Act of 2017 narrowed eligibility so that only real property is included. This means:

• Personal property—such as equipment, artwork, or vehicles—is excluded.
• Intangible assets, including partnership interests or business goodwill, are not eligible.
• Foreign real estate cannot be exchanged for U.S. property, and vice versa.

Remaining within IRS guidelines is essential to ensure the exchange receives full tax-deferred treatment.

How Long Do You Have to Hold Property in a 1031 Exchange?

The IRS does not mandate a specific holding period for investment properties in most 1031 exchanges. Instead, the determining factor is intent: was the property acquired and held as an investment? That question is central to qualifying under Section 1031.

Although no strict timeframe exists, the government has suggested one year on several occasions, leading many to treat it as a practical guideline. This aligns with the IRS distinction between short-term and long-term capital gains, which also occurs at the one-year mark.

Certain scenarios, however, do require a defined holding period. In a “related party” exchange, Section 1031 requires a minimum two-year holding period to qualify.

Advanced Strategies for Complex Transactions

For investors with more complex needs, additional 1031 exchange strategies are available. These include:

• Reverse Exchange — allows the acquisition of a replacement property before selling the relinquished one.
• Qualified Exchange Accommodation Arrangement (QEAA) — uses an Exchange Accommodation Titleholder (EAT) to temporarily hold property in compliance with IRS guidelines.

These advanced strategies are highly technical but can provide flexibility in competitive markets where timing is critical.

Work With Professionals With 1031 Exchange Experience

Completing a 1031 exchange requires a team of experienced professionals to manage the process with precision. With strict IRS rules, multiple moving parts, and critical deadlines, expert guidance ensures compliance and reduces risk. A qualified intermediary, supported by an experienced real estate advisory team, can help investors navigate the regulations and timelines involved.

The advisors at Sands Investment Group have extensive 1031 exchange experience. Our team provides clarity around requirements and options, helping investors unlock the full benefits of a tax-deferred exchange. Connect with a SIG Advisor today.