1031 Like-Kind Exchanges: How to Defer Capital Gains on a Commercial Property Sale

By Hank FasthoffJuly 5, 2026

When you sell a commercial property at a gain, you owe federal capital gains tax (up to 20 percent for long-term gains), depreciation recapture tax (25 percent on the accumulated depreciation), net investment income tax (3.8 percent for high earners), and potentially state tax depending on where the property is located. On a property you've held and depreciated for years, the combined tax can reach 30 to 40 percent of the gain. A 1031 exchange lets you defer all of it by reinvesting the proceeds into another qualifying property.

IRC § 1031 has been part of the tax code since 1921. It provides that no gain or loss is recognized on the exchange of real property held for productive use in a trade or business or for investment, if the property is exchanged solely for like-kind real property that will also be held for business use or investment. The tax is deferred rather than owed at closing; the gain carries forward into the replacement property through a reduced tax basis. But deferral lets you reinvest the full sale proceeds rather than paying tax and reinvesting what's left, and that compounding effect over multiple exchanges can produce substantially more wealth than selling and paying tax at each step.

What Qualifies

Since the Tax Cuts and Jobs Act of 2017, Section 1031 applies only to real property. Personal property, equipment, vehicles, artwork, and intangible assets no longer qualify. Both the relinquished property (the one you're selling) and the replacement property (the one you're buying) must be real property held for productive use in a trade or business or for investment.

"Like-kind" in real estate is broad. Any real property held for investment can be exchanged for any other real property held for investment, regardless of property type. You can exchange an office building for a warehouse, a retail center for raw land, or an apartment complex for a single-tenant industrial building. What doesn't qualify is property held primarily for sale (inventory, fix-and-flip projects) and personal-use property (your primary residence, a vacation home you don't rent out). Both the relinquished and replacement properties must be located in the United States.

The Two Deadlines

Every 1031 exchange is governed by two strict, non-extendable deadlines. Missing either one disqualifies the exchange entirely, and the IRS has granted no extensions for any reason other than a presidentially declared disaster.

Your 45-day identification period starts the day after you close on the sale of your relinquished property. Within those 45 calendar days, you must identify potential replacement properties in a written document, signed by you, and delivered to your qualified intermediary or another permissible party (but not your own agent, broker, or attorney). The identification must describe each property with enough specificity that it can be located (street address, legal description, or distinguishable name for real property).

Your 180-day exchange period starts on the same date. Within 180 calendar days after the sale of your relinquished property (or by the due date of your tax return for the year of the sale, including extensions, whichever comes first), you must close on the acquisition of the replacement property. The 180 days include the 45-day identification period, so you effectively have 135 days after the identification deadline to close.

These deadlines don't shift for weekends or holidays. If day 45 falls on a Saturday, your identification is due Saturday, not Monday. If day 180 falls on a Sunday, your exchange period ends Sunday.

How Many Properties You Can Identify

You can't identify an unlimited number of replacement properties. The IRS imposes three alternative rules, and you must satisfy at least one.

Under the three-property rule, you may identify up to three replacement properties regardless of their combined value. This is the most commonly used rule and the simplest. If you identify three properties and acquire one of them within the 180-day exchange period, the exchange is valid.

Under the 200 percent rule, you may identify more than three properties, but their combined fair market value can't exceed 200 percent of the fair market value of the relinquished property. If you sold a property for $2 million, you can identify any number of replacement properties as long as their combined value doesn't exceed $4 million.

Under the 95 percent rule, you may identify any number of properties of any combined value, but you must acquire properties representing at least 95 percent of the total value identified. This rule is difficult to satisfy in practice and is rarely used.

If your identification doesn't satisfy any of these rules, you've identified zero replacement properties, and the entire exchange fails.

The Qualified Intermediary

You can't touch the sale proceeds. If the money from the sale hits your bank account even for a single day, the exchange is disqualified. A qualified intermediary (QI) holds the proceeds from the sale of the relinquished property and uses them to acquire the replacement property on your behalf.

Your QI must be engaged before the closing of the relinquished property sale. Exchange documents must be signed before the relinquished property closes. At closing, the sale proceeds go directly to the QI, who holds them in a segregated account until the replacement property closing, at which point the QI uses the funds to complete the acquisition.

A QI can't be someone who has acted as your agent within the prior two years. Your attorney, your CPA, your real estate broker, and your employees are all disqualified from serving as QI. Use an independent exchange company that specializes in 1031 intermediary services.

One risk that receives insufficient attention is QI insolvency. Your exchange funds stay in the QI's account for weeks or months. If the QI files for bankruptcy, commingles funds, or otherwise can't meet its obligations, your exchange may fail and your proceeds may be at risk. Verify that your QI segregates exchange funds (rather than commingling them with operating funds), carries fidelity bond or errors and omissions insurance, and has a track record of completed exchanges.

Boot and Partial Exchanges

To fully defer all gain, you must reinvest the entire net sale proceeds into replacement property of equal or greater value, and you must replace all debt on the relinquished property with equal or greater debt on the replacement property (or make up the difference with additional cash).

If you receive cash, property, or debt relief that doesn't qualify as like-kind property, that non-qualifying amount is "boot," and it's taxable. Common sources of boot include taking cash out of the exchange (even a portion of the proceeds), acquiring replacement property for less than the sale price of the relinquished property, reducing your mortgage debt without replacing it with additional cash or new debt, and receiving non-real-property items (personal property, furniture, fixtures) as part of the replacement property acquisition.

A partial exchange is still valid. If you sell a property for $3 million and reinvest $2.5 million in replacement property, you've completed a partial exchange. You defer gain on the $2.5 million and recognize gain on the $500,000 of boot.

Reverse Exchanges

Sometimes the replacement property you want becomes available before you've sold your relinquished property. A reverse exchange lets you acquire the replacement property first and sell the relinquished property afterward, within the same 180-day window.

Reverse exchanges are more complex and more expensive than forward (delayed) exchanges. An exchange accommodation titleholder (EAT) takes title to the replacement property and "parks" it while you sell the relinquished property. You have 45 days after the EAT acquires the replacement property to identify the relinquished property you'll sell, and 180 days to complete the sale. You can't hold title to both properties simultaneously during the exchange period.

Reverse exchanges involve additional legal fees, EAT fees, financing costs (the EAT may need to obtain a loan to acquire the replacement property), and holding costs during the parking period. But when the right replacement property is available and you can't afford to wait, a reverse exchange preserves the tax deferral.

Improvement and Construction Exchanges

An improvement exchange (also called a build-to-suit exchange) lets you use exchange proceeds to construct improvements on the replacement property before taking title. The improvements must be completed within the 180-day exchange period, and the EAT holds title during construction. This structure lets you acquire land and build a custom facility using tax-deferred exchange proceeds, but the construction timeline must fit within the 180-day window, which can be tight for major projects.

The Tax Basis Carries Forward

A 1031 exchange is a deferral, not an elimination, of tax. Your tax basis in the replacement property equals your basis in the relinquished property (plus any boot paid, minus any boot received). That reduced basis means less depreciation on the replacement property and a larger taxable gain when you eventually sell without exchanging.

If you continue exchanging throughout your lifetime and never sell outright, the deferred gain may never be taxed. Under current law, heirs who inherit appreciated real property receive a stepped-up basis equal to the property's fair market value at the date of death. That step-up eliminates the deferred gain, effectively converting the deferral into a permanent exclusion for heirs. This is one of the most powerful wealth-transfer aspects of a 1031 exchange strategy.

Common Mistakes

Missing the 45-day identification deadline. This is the most common failure. Competitive markets and limited inventory can leave you scrambling, and there are no extensions.

Identifying too many properties without satisfying the 200 percent or 95 percent rule. If you identify four properties with a combined value exceeding 200 percent of the relinquished property and don't acquire 95 percent of the identified value, you've identified nothing.

Taking constructive receipt of the proceeds. If your exchange agreement doesn't contain the required restrictions on your ability to receive, pledge, borrow, or benefit from the exchange funds (the so-called g(6) restrictions under Treas. Reg. § 1.1031(k)-1(g)(6)), the QI safe harbor fails.

Failing to replace debt. If your relinquished property had a $1 million mortgage and your replacement property has a $600,000 mortgage, the $400,000 of debt relief is boot, and it's taxable.

Using a QI who isn't independent. Your attorney, CPA, and broker are disqualified persons. Engaging one of them as your QI invalidates the exchange.

Practical Recommendations

Engage a QI before you list the relinquished property. Exchange documents must be in place before the relinquished property closes, and arranging a QI just before closing creates unnecessary risk.

Start identifying replacement properties before the relinquished property closes. The 45-day clock starts ticking at closing, and 45 days in a competitive market isn't much time. Having a shortlist of candidates before day one puts you ahead of the 45-day clock.

Structure the exchange with your CPA and your attorney. The CPA handles the tax analysis (basis calculation, boot computation, depreciation recapture). Your attorney handles the exchange documents, the purchase agreement provisions, and coordination with the QI. Both should be involved before the relinquished property is sold.

Report the exchange on IRS Form 8824 (Like-Kind Exchanges) for the tax year in which the relinquished property was transferred. Even though no gain is recognized, the exchange must be reported.

Consider a 1031 exchange as part of a long-term investment strategy, not just a single transaction. Investors who exchange repeatedly build portfolios with compounding equity that would have been diminished by taxes at each sale. Combined with the stepped-up basis at death, a lifetime of tax-deferred exchanges can transfer substantially more wealth to the next generation than selling and reinvesting after tax.