§1031 Exchange
Mechanics

Statutory basis

• IRC §1031. Like-kind exchange deferral. Post-TCJA 2017 limited to real property only (personal property eliminated).
• Treas. Reg. §1.1031(k)-1. Deferred exchange safe-harbor rules. Defines QI, identification, and timing.
• Rev. Proc. 2000-37. Reverse exchange safe-harbor.
• Rev. Rul. 2004-86. DST interests qualify as real property for §1031.

Qualifying property

• Investment or trade/business use. Rental property, raw land held for investment, farm, commercial. NOT primary residence, NOT dealer inventory (flipping).
• Like-kind. All real property is like-kind to all real property (for investment use). Raw land ↔ apartment. Farm ↔ office. US-to-foreign NOT like-kind.
• Post-TCJA real property only. Personal property exchanges eliminated 12/31/2017. Equipment, machinery no longer qualify.

The deadlines

Day 0:  Sale of relinquished property closes
        QI receives proceeds (you never touch them)

Day 1-45: Identification period
        Identify replacement property/properties in writing
        Signed document delivered to QI (or other party)
        No extensions (except federally-declared disasters)

Day 46-180: Exchange period
        Close on replacement property/ies
        Must be one of the identified properties
        Earlier of 180 days or tax return due date

Example timeline:
  Sept 15: Sale closes → QI holds $1.2M
  Oct 30:  45-day ID deadline → identify 3 properties
  Mar 14:  180-day deadline → must close replacement

Miss a deadline = exchange fails = capital gain recognized

Identification rules

Choose ONE of three:

• 3-property rule. Identify up to 3 properties of any value. Most common.
• 200% rule. Identify any number of properties if total FMV ≤ 200% of relinquished property value.
• 95% rule. If identified more than 3 and exceeded 200%, must acquire 95%+ of identified FMV. High risk.

Identification must be in writing, signed, delivered to QI or seller. Must unambiguously describe property (legal description, street address, or meaningful ID).

Qualified Intermediary (QI)

The QI is the linchpin of the deferred exchange. QI holds sale proceeds in a separate account, buys the replacement property on taxpayer’s behalf, transfers title. Taxpayer never touches funds — constructive receipt disqualifies exchange.

• Disqualified parties. Cannot use agent within prior 2 years — your attorney, CPA, broker, investment advisor, or family member. Must be independent.
• Institutional QIs. IPX1031, Asset Preservation Inc (API), Wilmington Trust, Accruit, Exeter 1031, First American.
• Fee. $750–2,500 for standard forward exchange. $5k–25k for reverse or complex.
• Safety. QI holds your entire sale proceeds for up to 180 days. QI bankruptcy risk is real — request segregated accounts, bonding, errors-and-omissions insurance, and multi-billion dollar sponsor (institutional QIs).

Exchange types

• Forward (standard) exchange. Sell first, buy replacement within 180 days. Most common.
• Reverse exchange. Buy replacement first, sell relinquished within 180 days. Requires EAT (Exchange Accommodation Titleholder) to park replacement property. Complex and expensive ($10k–30k+).
• Improvement exchange. Construct improvements on replacement property during 180-day window, using exchange funds. EAT holds title during construction. All construction must complete within 180 days.
• Build-to-suit. Variant of improvement exchange for ground-up construction.

Boot and debt replacement

Relinquished: $1M sale, $400k mortgage → $600k equity
Replacement:  $1.2M buy, $500k mortgage → $700k equity

Rules:
  1. Replace ALL equity (or pay tax on shortfall = "cash boot")
  2. Replace ALL debt (or pay tax on shortfall = "mortgage boot")
  3. Debt reduction can be offset by adding cash equity

Example above:
  Equity: went from $600k → $700k (added $100k cash from outside)
  Debt: went from $400k → $500k (increased debt)
  Result: no boot, 100% deferred

Scenario 2 — buy cheaper replacement:
  Relinquished: $1M / $400k mortgage / $600k equity
  Replacement:  $800k / $300k mortgage / $500k equity
  Equity: $600k → $500k → $100k cash boot = taxable gain
  Debt:   $400k → $300k → $100k debt relief = "mortgage boot" = taxable
  Total boot: $200k at capital gains rate

Rule: always trade equal or up in both value AND debt.

Basis carryover

Deferred, not forgiven. Your adjusted basis in the relinquished property carries over to the replacement (adjusted for boot and any new cash).

New basis = Old adjusted basis
          + Boot paid (cash added)
          − Boot received (cash out, mortgage relief)
          + Gain recognized (taxed boot)

Depreciation:
  - Deferred basis portion continues on old schedule
  - New cost basis portion (improvements + boot) depreciates fresh
  - Requires careful tracking across 27.5-year or 39-year schedules

Related-party rules (§1031(f))

Exchange with a related party (family, controlled entity) requires both parties to hold properties 2+ years after exchange. Selling within 2 years disqualifies exchange retroactively. Extensive anti-abuse provisions. Avoid related-party exchanges unless specific need and advisor-led structuring.

Common pitfalls

• Missed 45-day ID. No extensions. Exchange fails. Capital gain recognized.
• Constructive receipt. Cash passes through taxpayer’s hands or control. Even one day of constructive receipt kills exchange.
• QI bankruptcy. QI holds $1M+ of your capital. 2008 saw several QI failures with investor losses. Vet QI carefully.
• Disqualified party as QI. Your long-time CPA acts as QI. IRS deems disqualified. Entire exchange fails.
• Boot not planned. Replacement debt lower than relinquished. Unexpected mortgage boot = unexpected tax.
• Primary residence confusion. Vacation home used personally > 14 days/year or 10% of rented days = §280A personal. Doesn’t qualify for §1031. Convert to genuine rental for 2+ years first.
• Dealer property. Flippers hold inventory. Inventory doesn’t qualify for §1031. Documentation of investment intent matters.
• Reverse exchange mechanics. EAT arrangements are complex and expensive. Don’t DIY. Retain experienced QI and attorney.
• State non-conformity. California claws back §1031 gain at future sale if replacement is out-of-state. PA doesn’t recognize §1031 at state level. NY has specific non-resident withholding rules.