1031 Exchanges
Defer capital gains tax by exchanging investment property into like-kind real estate — including DSTs — within the IRS 45-day identification and 180-day closing deadlines.
Overview
A 1031 exchange — named for Section 1031 of the Internal Revenue Code — lets an investor sell appreciated real estate and reinvest the proceeds into like-kind property without recognizing capital gains tax at the time of sale. Section 1031 has been part of the tax code since 1921. It allows the deferral of capital gains (and depreciation recapture) when an investor sells real property held for investment or business use and reinvests the proceeds into other 'like-kind' real property. Done correctly and repeatedly, an investor can defer tax across a lifetime of exchanges and potentially receive a stepped-up basis at death. The mechanics are unforgiving on timing. From the day the relinquished property closes, the investor has 45 calendar days to formally identify replacement property and 180 calendar days to close on it. Proceeds must be held by a qualified intermediary — never touched by the investor — and the replacement must carry equal or greater value and debt to fully defer the gain. DSTs have become a popular replacement option precisely because they can be identified and closed quickly within these windows.
How it works
01 Sell and escrow with a QI Before closing the sale, engage a qualified intermediary (QI) to receive the proceeds. If you take possession of the cash, the exchange fails. 02 Identify within 45 days Formally identify replacement property in writing — commonly under the 3-property rule or the 200% rule. Many investors identify a DST as a backup. 03 Close within 180 days Acquire the identified replacement property within 180 days of the original sale (or your tax-filing deadline, if earlier). 04 Match value and debt To defer 100% of the gain, reinvest all equity and replace all debt with equal-or-greater value; any shortfall ('boot') is taxable.
Timeline The 1031 exchange clock Calendar days from the sale of the relinquished property Day 0 Relinquished property closes Sale proceeds go to your qualified intermediary — not to you. The clock starts. Day 45 Identification deadline Identify replacement property in writing under the 3-property or 200% rule. Many investors identify a DST as a backup. Day 180 Closing deadline Acquire the replacement property. Match value and debt to defer 100% of the gain.
Benefits
Tax deferral Defer federal and state capital gains plus depreciation recapture, keeping more capital compounding in real estate. Portfolio repositioning Move from active to passive, from one sector to another, or from one geography to another — without a taxable event. Estate planning Heirs may receive a step-up in basis, potentially eliminating the deferred gain — a reason 'swap til you drop' is a common strategy. Leverage of proceeds Reinvesting pre-tax proceeds means more equity at work than an after-tax sale would allow.
Considerations & risks
Strict deadlines The 45- and 180-day clocks are calendar days with essentially no extensions; missing them disqualifies the exchange. Qualified intermediary required You cannot touch the proceeds. Choosing a reputable, bonded QI is critical to a valid exchange. Boot is taxable Cash taken out or debt not replaced is 'boot' and is taxed; full deferral requires matching value and debt. Like-kind, but real estate only Since 2018, 1031 applies only to real property; personal property no longer qualifies.
Compare
The two 1031 identification rules investors use most The two 1031 identification rules investors use most
Rule What it allows Best for
3-property rule Identify up to 3 properties of any value; close on one or more Most exchangers; allows a DST backup 200% rule Identify any number of properties so long as total value ≤ 200% of the sale Diversifying across several DSTs 95% rule Identify any number; must close on 95% of total identified value Rare; large multi-asset programs
A third 'reasonable' 95% rule also exists. Consult your CPA and QI.