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  5. Like-Kind Exchange

Like-Kind Exchange

Tax-deferred swap of investment real estate for similar property under IRS Section 1031.

Tax FilingInvestment Management

FAQs

What is a qualified intermediary in a 1031 exchange?

A qualified intermediary (QI), also called an accommodator or exchange facilitator, is an independent third party who holds the proceeds from the sale of the relinquished property until they are used to purchase the replacement property. The IRS requires that the exchanger never receive, pledge, borrow, or benefit from the sales proceeds during the exchange period. Using a QI ensures the exchanger never has constructive receipt of funds, which would disqualify the exchange and trigger immediate capital gains recognition.

Can you 1031 exchange into multiple replacement properties?

Yes—under the 1031 exchange rules, you can identify up to three replacement properties of any value (the three-property rule) or any number of properties as long as their aggregate fair market value does not exceed 200% of the relinquished property value (the 200% rule). You can ultimately close on one, some, or all identified properties. This flexibility allows investors to diversify their real estate portfolio through exchanges, splitting a single large property sale into multiple smaller acquisitions.

What happens to deferred 1031 gains when the replacement property is eventually sold?

When the replacement property is sold in a taxable sale (not another 1031 exchange), all accumulated deferred gains—including gains from prior exchanges in a chain—become taxable. The tax basis carries over from the original relinquished property, adjusted for the intervening years' depreciation. Many investors engage in continuous 1031 exchange chains, deferring gains indefinitely until death, when heirs receive a stepped-up basis that can eliminate the accumulated deferred gain entirely.

Related Terms

Step-Up in Basis

Tax rule resetting an inherited asset's cost basis to fair market value at the decedent's date of death.

Qualified Opportunity Zone

IRS-designated economically distressed area offering capital gains tax deferral and reduction for long-term investments.

Depreciation

The systematic allocation of a tangible asset's cost over its useful life, reducing its book value on the balance sheet each period.

Estate Planning

The process of arranging for the management and distribution of assets during life and after death, minimizing taxes and ensuring wishes are carried out.

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A like-kind exchange, commonly known as a 1031 exchange after the governing IRS code section, allows investors to defer capital gains taxes when selling investment or business-use real property by reinvesting the proceeds into another 'like-kind' property of equal or greater value. The tax is not eliminated—it is deferred until the replacement property is eventually sold in a taxable transaction.

The term 'like-kind' is broadly interpreted for real property: any real estate used in a trade, business, or held for investment qualifies as like-kind to any other such property. An investor can exchange a residential rental property for a commercial office building, an industrial warehouse for vacant land, or a retail strip center for a multifamily apartment complex—all qualify under 1031.

Strict timing rules govern 1031 exchanges. From the date of sale of the relinquished property, the investor has 45 days to identify up to three potential replacement properties (or more under alternative identification rules) and 180 days to close on the replacement. A qualified intermediary (QI) must hold the proceeds during the exchange—the investor cannot take constructive receipt of the funds.

Boot—any non-like-kind property received (cash, net debt reduction, personal property)—is taxable in the year of exchange even if the exchange otherwise qualifies. Investors typically structure exchanges to be entirely boot-free.

The Tax Cuts and Jobs Act of 2017 eliminated 1031 exchanges for personal property (equipment, vehicles, artwork), restricting them exclusively to real property. This change made depreciation recapture more immediately costly for businesses replacing equipment.

Estates that inherit 1031 exchange property benefit from a step-up in basis at death, potentially eliminating deferred gains entirely through generational transfer.