Calculate your tax deferral and identify replacement property requirements
From Schedule E over your holding period
Must be ≥ selling price for full deferral
Three Property Rule
You may identify up to 3 replacement properties of any value. Alternatively, you may identify more than 3 if their combined value does not exceed 200% of the relinquished property (200% rule). A Qualified Intermediary (QI) must hold the exchange proceeds — you cannot receive the funds yourself.
A 1031 exchange (named after Section 1031 of the IRS Code) allows real estate investors to sell an investment property and defer all capital gains taxes — including depreciation recapture — by reinvesting the proceeds into a "like-kind" replacement property. When executed correctly, this is one of the most powerful wealth-building tools in real estate: it allows your tax liability to compound alongside your portfolio rather than being extracted at each sale.
Despite the name, "like-kind" is very broadly defined for real estate. Any real property held for investment or business use can be exchanged for any other real property held for investment or business use within the United States. A single-family rental can be exchanged for an apartment building, raw land, a commercial property, or a vacation rental. Your principal residence does not qualify (it is not investment property), and foreign property cannot be exchanged for domestic property.
Boot is any property or cash received in the exchange that is not like-kind real estate. Common sources of boot include: cash you receive from the sale proceeds (not invested in the replacement property), debt relief (your old mortgage was higher than your new mortgage), and non-real-estate property received. Boot is taxable up to the amount of your realized gain. To avoid boot entirely, your replacement property must be of equal or greater value than the relinquished property, and you must reinvest all the equity and replace all the debt.
These are hard deadlines with no exceptions — missing them results in the entire gain becoming taxable. From the date you close on the sale of your relinquished property: (1) within 45 days you must identify potential replacement properties in writing to your Qualified Intermediary, and (2) within 180 days you must close on one of the identified properties. The clock runs simultaneously — you have 180 days total, not 45+180. Congress has provided limited extensions during declared national emergencies (COVID, certain hurricanes), but otherwise these dates are absolute.
A critical rule: you cannot receive the sale proceeds yourself, even briefly. The moment you receive the money, the exchange fails and all gain becomes immediately taxable. You must use a Qualified Intermediary (QI) — also called an exchange facilitator or accommodator — who holds the proceeds between the sale and the purchase. The QI is typically a specialized company; your real estate attorney, agent, or accountant cannot serve as QI if they have had a business relationship with you in the past 2 years.
Can I exchange into multiple replacement properties?
Yes. Under the Three Property Rule, you can identify up to 3 replacement properties and must close on at least one. Under the 200% Rule, you can identify more than 3 properties if their total fair market value doesn't exceed 200% of the relinquished property's value. Under the 95% Rule, you can identify any number of properties if you actually close on 95% or more of their combined value.
What happens to my tax liability if I hold the replacement property until death?
Your heirs receive a stepped-up basis to the fair market value at the time of your death, effectively eliminating all deferred capital gains and depreciation recapture forever. This is the 'exit strategy' for many 1031 exchange investors: exchange repeatedly, hold until death, and the deferred taxes disappear. The Tax Cuts and Jobs Act did not eliminate step-up in basis, though it has been proposed multiple times.
Can I move into the replacement property after the exchange?
Not immediately — the IRS requires the replacement property to be held for investment, not personal use. The IRS Safe Harbor (Revenue Procedure 2008-16) specifies that if you hold the replacement property for at least 24 months after the exchange, rent it out at fair market value for at least 14 days in each of the two 12-month periods, and limit personal use to less than 14 days per period, you have met the investment-use requirement. After meeting the safe harbor, you could convert it to a primary residence and potentially qualify for the Section 121 exclusion.
What is a Qualified Intermediary and how do I find one?
A Qualified Intermediary is a company or individual that facilitates 1031 exchanges by holding exchange proceeds between transactions. Look for QIs that are members of the Federation of Exchange Accommodators (FEA), which has ethical and competency standards. Avoid anyone your real estate agent recommends who also has a business relationship with you — QIs must be truly independent. Fees typically range from $800–$1,500 per exchange.
Can I do a 1031 exchange on a vacation home?
Possibly, if it qualifies as investment property under the IRS's safe harbor rules. The IRS (Rev. Proc. 2008-16) provides that a vacation home qualifies for 1031 treatment if: you own it for at least 24 months, it is rented at fair market value for at least 14 days per year, and your personal use does not exceed 14 days or 10% of the days rented (whichever is greater). A pure vacation property with no rental history will likely fail scrutiny.
VerticalRent maintains a complete cost basis log, tracks every dollar of depreciation, and generates your Schedule E summary at tax time — so you always know where you stand before a 1031 exchange.
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