1031 Exchange Rules Every CPA, Attorney and Real Estate Advisor Should Know Before a Client Sells
When a client is preparing to sell appreciated investment real estate, the sale itself is only part of the planning conversation.
A CPA may be looking at the potential tax consequences. A commercial real estate professional may be preparing a property for the market. An attorney may be reviewing ownership or entity structure. A financial professional may be helping the client determine what comes next.
For all of them, one question is worth asking before the property closes:
Has the client evaluated whether a 1031 exchange may apply?
A Section 1031 exchange may allow a taxpayer to defer recognition of gain when qualifying real property held for business or investment is exchanged for other qualifying like-kind real property.
It is not a tax loophole. It is established under Internal Revenue Code Section 1031.
The challenge is that the opportunity comes with specific rules, deadlines and coordination requirements. By the time a client asks about an exchange after receiving the sale proceeds, some planning options may already be unavailable.
What is a 1031 exchange?
A 1031 exchange allows qualifying investment or business real estate to be exchanged for other qualifying real property while potentially deferring recognition of taxable gain.
The important word is deferral.
A successful exchange generally does not erase the underlying tax liability. Instead, basis and deferred gain considerations carry into the replacement property and may affect a later taxable disposition.
The IRS also makes clear that Section 1031 generally applies to real property held for investment or productive use in a trade or business. A primary residence or property held primarily for resale generally does not qualify under the same rules.
The IRS provides an overview of like-kind exchanges and qualifying real estate here.
“Like-kind” does not necessarily mean the same property type
One of the most common misconceptions is that someone selling an apartment property must buy another apartment property.
For qualifying real estate, “like-kind” is broader.
An investor may potentially exchange one category of investment real estate for another, provided the properties and their intended use meet applicable requirements.
That can make the planning discussion significantly broader.
A client selling rental or commercial property may be able to consider replacement real estate across different markets and property categories rather than simply recreating the property they already owned.
Why a Qualified Intermediary should be involved before closing
A typical deferred 1031 exchange requires careful control over the sale proceeds.
The taxpayer generally should not receive or control those funds directly. Instead, a Qualified Intermediary, or QI, is commonly engaged before the relinquished property closes to facilitate the exchange.
The IRS addresses the use of Qualified Intermediaries and deferred exchanges in its Form 8824 instructions.
For CPAs, attorneys and brokers, this creates one of the most important practical takeaways:
Do not wait until after closing to begin the 1031 conversation.
The earlier the client’s professional team coordinates, the more time there is to address exchange mechanics, replacement-property planning, ownership questions and documentation.
The 45-day and 180-day deadlines
Once the relinquished property is transferred, two deadlines become critical.
The taxpayer generally has:
45 days to identify potential replacement property.
180 days to acquire the replacement property, subject to the applicable tax-return deadline.
Those periods run at the same time. The 180-day period does not begin after the 45-day identification period ends.
That makes the first several weeks after closing particularly important.
Waiting until day 35 or 40 to begin looking seriously at replacement property can significantly reduce the investor’s flexibility.
How many replacement properties can be identified?
Treasury regulations provide several identification methods.
The most familiar is the Three-Property Rule, which generally permits a taxpayer to identify up to three potential replacement properties regardless of their value.
Another is the 200% Rule, which may allow more than three properties to be identified if their combined fair market value does not exceed 200% of the value of the relinquished property or properties.
There is also a more restrictive 95% Rule for certain situations.
The detailed requirements appear in Treasury Regulation §1.1031(k)-1.
For the advisory team, the broader lesson is more important than memorizing every rule: replacement-property identification should be treated as a planning process, not merely a deadline.
Does a client have to reinvest everything?
Not necessarily.
A 1031 exchange does not always have to be an all-or-nothing transaction.
An investor may potentially complete a partial exchange. However, cash or other non-like-kind property received as part of the transaction may create taxable gain, commonly referred to in 1031 planning as boot.
That can become relevant when a client wants to reduce leverage, retain part of the sale proceeds or purchase a replacement property with a lower value.
The transaction does not automatically fail simply because the economics are different. Instead, the tax consequences should be evaluated with the client’s tax professionals.
Ownership structure deserves attention
Another issue that often requires early coordination is who owns the property.
Investment real estate may be owned individually, jointly, through an LLC, partnership, corporation or trust.
Those structures are not necessarily treated the same for federal tax purposes.
Changes in ownership before or during an exchange may therefore create additional tax or legal questions.
This is an area where CPAs, attorneys, QIs and financial professionals can add considerable value simply by identifying the issue early and coordinating with one another.
Where can a Delaware Statutory Trust fit?
For some accredited investors, a Delaware Statutory Trust, or DST, may be evaluated as a potential 1031 replacement-property structure.
In Revenue Ruling 2004-86, the IRS concluded that an interest in the specific DST structure described in the ruling could be treated as an interest in real property for Section 1031 purposes.
DSTs can provide fractional beneficial ownership in professionally managed real estate and may be considered by investors seeking alternatives to purchasing and managing another property directly.
They may also be considered when an investor needs additional replacement-property options or wants to allocate an exchange among multiple real estate interests.
But a DST is not appropriate for every investor.
DST investments can involve significant risks, including illiquidity, loss of principal, limited investor control, real estate and financing risk, fees and expenses, and distributions that may fluctuate or stop.
Many DST offerings are private placements available only to accredited investors. The SEC provides additional information about accredited investor qualifications at Investor.gov.
The most important conversation happens before the sale
Professionals do not need to become 1031 specialists to add value.
Sometimes the most useful question is simply:
“Before you close, have you evaluated whether a 1031 exchange makes sense for this transaction?”
For a broker, that question may help a seller think beyond the disposition.
For a CPA, it can begin a tax-planning conversation before the transaction is complete.
For an attorney, it may identify ownership or documentation issues early enough to address them.
And for a financial professional, it creates time to evaluate appropriate replacement-property and investment options as part of the client’s broader financial strategy.
The goal is not to make every property sale a 1031 exchange.
The goal is to make sure clients understand their options before timing makes the decision for them.
Frequently Asked Questions
How long does a 1031 exchange take?
A qualifying deferred exchange generally provides 45 days to identify replacement property and up to 180 days to acquire it, subject to applicable tax-return deadlines.
Does a replacement property have to be the same kind of building?
Generally, no. “Like-kind” real property is broader than identical property type, provided the properties satisfy the applicable Section 1031 requirements.
Can an investor do a partial 1031 exchange?
Potentially. A taxpayer may complete an exchange while receiving some cash or other non-like-kind property, although that portion may trigger recognized gain.
Can a DST be used in a 1031 exchange?
Certain properly structured DST interests may qualify as replacement property under Section 1031. Investors should separately evaluate the investment’s suitability, offering terms and risks.
Ready to Discuss a Client Situation?
If you are considering a 1031 exchange yourself, or you are a CPA, attorney, Qualified Intermediary, commercial real estate professional or other advisor working with a client who may be selling appreciated real estate, we are happy to be a resource.
You can call me directly at +1 (801) 815-6619 or schedule a free consultation here:
You can also register and download our free educational eBooks to learn more about 1031 exchanges, DSTs and other tax-aware investment strategies.
I’m based in Salt Lake City, Utah, with an office in Dallas, Texas, and I work with investors across all 50 states, helping individuals explore tax-advantaged real estate and private-market strategies that may align with their financial goals.
Disclosure:
This content is provided for educational purposes only and should not be construed as investment, legal, tax, or accounting advice. Investors should consult their financial professional regarding their specific circumstances before making any investment decision.
Portions of the written content in this article were assisted by artificial intelligence (AI) technology tools and reviewed by 1031 DST Group for quality and compliance. Investments discussed may be speculative, illiquid, may not be suitable for all investors and may involve risks, including the potential for loss of principal. Always consult with a qualified tax advisor or financial professional.. Such investments are generally available only to qualified or accredited investors. Some investments such as Alternative investments and DSTs involve significant risks and may be illiquid, speculative, and suitable only for accredited investors. Accredited investors are defined under SEC Rule 506 of Regulation D. Generally, an investor is deemed accredited if their net worth is greater than $1,000,000 exclusive of their primary residence and/or their annual income exceeds $200,000 for the current and past two years. Click here to learn more.
Ray DeWitt is a Registered Representative of Realta Equities, Inc. and an Investment Advisory Representative of Realta Investment Advisors, Inc. Investment Advisory Services are offered through Realta Investment Advisors Inc., an SEC registered investment advisor. Securities are offered through Realta Equities, Inc., Member FINRA/SIPC. Neither Realta Equities, Inc. nor Realta Investment Advisors Inc. is affiliated with C-Suite Network Or 1031 DST Group. Realta Wealth is the trade name for the Realta Wealth Companies. The Realta Wealth Companies are Realta Equities, Inc., Realta Investment Advisors, Inc., and Realta Insurance Services, which consist of several affiliated insurance agencies.