Essential 1031 Exchange Rules for 2025

The 1031 exchange is a strategic tool real estate investors use to swap properties while cashing in on tax benefits. With a 1031 or like-kind exchange, you can sell a rental property, defer the capital gains liability, then reinvest those funds by purchasing a property of equal or greater value. Of course, the IRS has complex rules about property qualifications and the exchange process. But this strategy provides landlords with multiple benefits, from tax deferrals to building generational wealth.

The key to a successful 1031 exchange is preparation, and TurboTenant is here to help! Use our built-in reports to evaluate your rentals and decide which one to sell as part of the swap. And as you prep your unit for the sale, track those costs with our integrated accounting software, REI Hub. By keeping up with your outlays as you go, you’ll ensure your books are accurate — another must for the 1031 process.

Ready to learn about the must-know 1031 exchange rules for rental property? Let’s get started!

1. 1031 Exchanges Are Also Known as “Like-Kind” Exchanges

One of the key 1031 exchange rules is that only like-kind properties qualify — hence the nickname “like-kind exchanges.” Just remember that you may only swap properties that have a similar purpose and value. Those properties must be for business or investments, and the net market value of each successive property must rise.

For example, you could exchange a single-family rental for any of these properties:

• a duplex
• a strip mall
• an apartment building
• an unimproved lot
• another single-family rental

So, what doesn’t count as a like-kind exchange? Intangible or personal property. The IRS doesn’t permit investors to swap an investment property for a residence or vacation home with 100% personal use. Property bought with the intent to resell, like a house flip, is also excluded. Plus, only properties within the United States qualify for 1031 swaps.

Highlight: The IRS gives investors wiggle room for what qualifies as like-kind properties; the main requirement is that personal property isn’t involved. Only properties in the US held for investment or business purposes qualify.

2. 1031 Exchange Deadlines

How does a 1031 exchange work? The process has a three-part timeline that’s absolutely critical. The countdown clock starts the day you sell your investment property.

Sale of Relinquished Property: Day 1

The property you choose to sell is called the relinquished property. Note that during a like-kind exchange, the proceeds from selling relinquished property go to an intermediary, not to you. You may not receive the proceeds even temporarily. Those funds go to an escrow account until you close on your replacement property.

The Identification Period: Days 1–45

Once your relinquished property sells, the identification period begins. You have 45 days to search for, evaluate, and identify one or more replacement properties. During this time, you’ll do market research, engage real estate agents, and analyze properties’ suitability.

By the end of the 45th day, you must designate a replacement property in writing, notifying your intermediary. This letter must include a legal description of the property you want to buy and your signature. IRS regulations allow you to name three properties as designated replacements as long as you close on at least one of them. And in certain situations, you may name more than three.

The Exchange Period: Days 46–180

Once 45 days have passed, you have 135 days to purchase the replacement properties you named in the letter to your intermediary. The 180-day rule is that you must close on the replacement property within 180 days of selling the relinquished property or after your tax return is due, whichever is earlier.

What happens if you miss a 1031 exchange deadline?

Missing a deadline during a like-kind exchange has serious consequences. If you don’t follow the timeline requirements, you can invalidate the exchange, which can trigger immediate tax liability with capital gains. Plus, you could face legal problems for noncompliance, along with an IRS audit, interest, fines, and penalties.

Highlight: The timeline stages are concurrent — it’s not 45 days, then 180 additional days. It’s 180 days total, and the timeline starts as soon as you sell the relinquished property.

3. You Can’t Use an Exchange to Downsize Your Investment

Sometimes, investors may want smaller or less expensive properties in their portfolios, but with the IRS 1031 exchange rules regarding property value, downsizing isn’t an option with a like-kind swap.

So what are the replacement property value requirements for 1031s?

One requirement is that the replacement property must be of equal or greater value than the property you’re selling. That’s why downsizing doesn’t really fit in with the 1031 strategy.

Let’s say you sell one property for $500,000, then buy a replacement property for $400,000 and pocket the difference.

That difference, the leftover proceeds from the sale, is called the boot. If you cash out part of the proceeds, then you can be taxed on that amount. Although this option may lower your tax liability, it doesn’t take full advantage of the like-kind exchange’s potential.

Don’t Downsize — Diversify

Most investors think a 1031 swap has to be a 1:1 exchange. However, you can exchange one investment for multiple properties, which helps you get around the downsizing issue.

Picture this: You own an apartment building worth $700,000. You can sell that building as part of a 1031 exchange and purchase five single-family residences worth $210,000 each. The combined value of the replacement properties exceeds the value of your relinquished property.

The IRS says you can identify more than three replacement properties during the 45-day identification period. However, the total aggregate value of the identified properties may not exceed 200% of the total value of the relinquished property. By swapping one investment for multiple properties, you can diversify your portfolio and reduce your tax liability.

Highlight: The like-kind exchange isn’t limited to a 1:1 swap. You can sell one property, then purchase multiple properties to help diversify your portfolio and avoid paying taxes on leftover proceeds from the sale.

4. Types of 1031 Exchanges

Not all 1031 exchanges are the same. There are actually four types of like-kind exchanges:

Construction or Improvement Exchange

Also known as a build-to-suit exchange, this property swap uses proceeds from the sale of the relinquished property to go toward renovations for the replacement property. This method allows for improvements ranging from simple repairs to the current structure to construction of a brand-new building. Keep in mind that the 180-day rule still applies to construction exchanges. The improvements must be completed by the deadline.

Delayed Exchange

This is the most common structure where an investor works with a qualified intermediary to sell a property and purchase a replacement property within 180 days. The intermediary holds the proceeds from the sale until the replacement purchase.

Reverse Exchange

In a reverse exchange, you buy the replacement property before selling the relinquished one. When you purchase the new property, the title transfers to an exchange accommodation titleholder, then you identify which property you want to swap.

Simultaneous Exchange

When an investor sells a property and buys a replacement in one extended closing, it’s considered a simultaneous, or drop-and-swap, exchange. The strict timing required for this type of exchange makes them less common now.

Highlight: The 45- and 180-day rules still apply in reverse exchanges, but this option helps in competitive markets when investors need to close quickly or deal with competing offers.

5. Finding a Qualified Intermediary

According to IRS regulations, the property owner may not take control of the proceeds before the exchange is complete. If an investor receives any funds related to the sale of the relinquished property, the entire transaction may be disqualified as a like-kind exchange. In that case, all the proceeds immediately become taxable. That’s why working with a qualified intermediary or exchange facilitator is crucial — you need someone to hold those proceeds and walk you through the requirements until the exchange is finalized.

The IRS also has restrictions on who can act as an intermediary during an exchange. When someone has acted as an agent for the investor within the last two years, that person may not act as a qualified intermediary for the exchange. The IRS considers anyone in these roles as an agent:

• accountant
• attorney
• employee
• investment banker
• investment or property broker
• real estate agent

You must find an experienced, independent third party to act as your intermediary, and it’s especially important to consult with a tax professional or attorney for large transactions. Requirements for intermediaries may vary from state to state. When you’re ready to search for an intermediary, check with your bank or the Federation of Exchange Accommodators to find qualified candidates in your area.

Highlight: Besides the IRS requirements, some states also have regulations for qualified intermediaries, so ask your legal advisor about the requirements in your state.

6. Benefits and Disadvantages of a 1031 Exchange

Pros of Like-Kind Exchanges

Most real estate investors think of tax benefits when considering a like-kind exchange, but the advantages go beyond capital gains deferrals:

• Consolidation of properties: Need to make a major update to your portfolio? Exchange multiple properties for one to change your investment strategy.
• Depreciation reset: A new depreciation schedule based on the cost basis of the replacement property helps you maximize your depreciation deductions and lower your annual tax liability.
  • Need some help with your property’s depreciation? Try TurboTenant’s depreciation calculator. And with our integrated bookkeeping software through REI Hub, you can simplify tracking your rental’s depreciation.
• Portfolio growth: Exchanging one investment for multiple properties of lesser value helps you diversify and strengthen your portfolio.
• Re-investment opportunities: Without the burden of capital gains, you’ll have more cash to re-invest in a new property — one with a potentially better ROI than your current property.
• Tax deferral: Limited or no taxes are due at the time of the exchange, allowing your investments to grow tax deferred. Then when it’s time to sell your investment for cash, you’ll only pay long-term capital gains and depreciation recapture taxes once.

Highlight: A 1031 exchange is a strategic tool not just for deferring taxes but for updating and growing your portfolio through smart investment opportunities.

Cons of a 1031 Exchange

A 1031 exchange is a powerful real estate investment strategy, but it comes with significant challenges to consider too:

• Close scrutiny: Like-kind exchanges are heavily monitored, so accurate bookkeeping is a must. Without organized books, you risk incurring tax penalties.

Cloud-based accounting software like REI Hub helps you stay organized and monitor your financials during intricate transactions, like a 1031 exchange.

• Complicated requirements: The IRS has a complex set of rules regulating 1031 swaps, and you’re required to work with an intermediary. Be prepared to spend time researching and organizing a support team to help you through the process.
• High transaction fees: Working with qualified intermediaries comes with a cost, typically between $600 and $1,200. Plus, administration fees for like-kind swaps can run another $600 to $1,200, with additional fees if multiple properties are involved.
• Increased pressure: Short timelines can lead to stress and competition, especially in markets with high demand for property.

You need to move fast and have reliable information during a 1031 exchange. Make sure your rental property data and reporting systems are in place before you begin the process. TurboTenant’s property management software enables you to make informed decisions, even when you’re on a deadline.

• Not tax-free: Capital gains and depreciation recapture taxes aren’t eliminated with a 1031. They’re simply delayed until the property is sold in the future — if it’s not part of another 1031 exchange.
• Potential for additional taxes: Even with a successful 1031 exchange, you may owe taxes at the time of the swap. If the mortgage on the replacement is lower than your relinquished property, you may be taxed on it. Boot is taxable too.
• Strict deadlines: The 45- and 180-day deadlines are not flexible. The IRS doesn’t grant extensions for like-kind exchanges unless you’re involved in a federally declared disaster.

Highlight: Like-kind exchanges aren’t a way to get out of paying taxes; you’re simply moving your tax liability to a later date.

Interested in hearing from an actual investor with experience in a 1031 exchange? We’ve got you covered with a recent episode of our Be a Better Landlord podcast. Check out our conversation about 1031 exchanges with Kayla Mahoney, a commercial real estate advisor from Capital Property Group.

7. When Not to Do a 1031 Exchange

In some situations, the drawbacks of a 1031 exchange mean it may not be the best option for you.

Are you downsizing?

If you need to scale your portfolio back, trading one property for others of equal value will not help. Let’s say you merge multiple properties into one through an exchange. With that one more costly property, you may set yourself up for increased management responsibilities or property taxes. That goes against your goal of scaling back.

Do you have tax losses to use?

Do you have net operating losses or passive activity losses? If so, check when they will expire. It may be more beneficial for you to use those losses to offset some — or potentially all — of the gains when you sell appreciated property.

Do you need cash immediately?

The proceeds from selling your relinquished property go straight to an intermediary, then to the seller of the replacement property. The cash doesn’t go to you. If you need cash, a 1031 sale won’t help unless you receive some of the boot. Remember that the IRS will tax that amount, and it’s rarely the most economical way to get cash, from a tax standpoint.

Does your property qualify?

Remember, only properties held for business or investment purposes can be part of a like-kind exchange. House-flippers, this disqualifies your flips since you bought them with the intent to sell. A personal residence or vacation home won’t qualify, but a few exceptions exist.

The 1031 Exchange 5-Year Rule

The 5-year rule, or the 5-year holding period, is part of the American Jobs Creation Act of 2004. With this rule, an investment property can become a primary residence, or vice versa, and the owner may sell the property and defer their capital gains tax if they meet these conditions:

• The individual has held the property for five years.
• The individual has lived on the property for at least two of the previous five years.

Note that the investor’s residential years don’t need to be consecutive. So you could live in a property for one year, rent it for three years, then live in it for another year before selling it. But you’re not required to live on the property during the time of the sale either.

Is the tax liability acceptable?

Have your tax advisor calculate your potential liability if you sell your property outright. If your property might sell at a loss, you wouldn’t have capital gains to defer. Recognizing losses in the current term is usually preferable to deferring them, so an exchange may not be worth the work. Even if you sell and have some gains, if the tax projections are manageable, you can avoid the hassle and additional costs associated with 1031 swaps.

Need a quick way to estimate your capital gains? Use our capital gains tax calculator to help with your financial and investment planning.

Is your legal entity on board?

According to the same taxpayer rule, the entity that purchases the replacement property must be the same entity that sold the relinquished property. Did you purchase the property you want to exchange through a multi-member LLC? If so, your LLC and each member must sign off on the replacement property. There are some exceptions for entities structured as tenants-in-common or Delaware statutory trusts.

Highlight: Like-kind swaps are not always the best option. Before starting a 1031 exchange, discuss your situation and goals with your tax and legal advisors to determine whether you’ll benefit from an exchange.

8. The Only Way to Make Tax Deferrals Permanent

If you’re concerned about your capital gains, you could continually exchange properties instead of selling them outright. This strategy is also known as a continuous or rolling exchange. With this method, you would defer your capital gains liability indefinitely. However, if you’re looking for a way to defer your tax deferrals permanently, there’s the “swap until you drop strategy.”

When you hold a replacement property until your death, you can leave the property to your heirs. Upon your death, the basis for your investment property steps up to its current market value. So, if your heirs decide to sell the property, they may do so with limited or no capital gains taxes. That makes like-kind swaps a powerful tool for building generational wealth.

Estate planning is key here, though. Work with a tax advisor who specializes in real estate tax planning. That way, you can evaluate the tax implications specific to your situation and plan ways to minimize the tax burden for you and your heirs. Consult with your lawyer as well to ensure your plans are in order.

Highlight: The only way to permanently defer capital gains taxes is to leave the property to your heirs. If they sell the property at its stepped-up basis, they’ll have little or no capital gains taxes to pay.