What Is a 1031 Exchange? Know the Rules

A 1031 exchange lets investors defer capital gains tax on the sale of one investment property by reinvesting the proceeds into a like-kind property.

The replacement property must be identified within 45 days, and the exchange must be completed within 180 days.

The 45-day and 180-day time periods for a 1031 exchange run concurrently, starting when the relinquished property is transferred.

One of the most significant benefits of 1031 exchanges is their potential for estate planning. When a property owner dies, the owner’s heirs inherit the property at its stepped-up market value, and do not have to pay the deferred capital gains tax. A 1031 exchange can defer tax during the property owner's life; if the replacement property is held until death, Section 1014 may eliminate the built-in gain for heirs.1827

Depreciation enables real estate investors to pay lower taxes by deducting the costs of wear and tear on a property over its useful life.

When that property is eventually sold, the IRS will want to recapture some of those deductions and factor them into the total taxable income. A 1031 exchange can help to delay that event by essentially rolling over the cost basis from the old property to the new one that is replacing it. In many 1031 exchanges, the carryover basis generally continues under the old property's depreciation schedule, subject to IRS rules and exceptions.