1031 Exchange Process

Step-by-Step Guide for Investors

A 1031 exchange is a powerful tax-deferral strategy that allows real estate investors to swap investment properties while avoiding immediate capital gains taxes. However, to qualify, the IRS requires strict compliance with timelines and procedures. Here’s a step-by-step guide to help you navigate the 1031 exchange process successfully.

Step 1: Prepare for Your 1031 Exchange Before Selling

The 1031 exchange process starts before you sell your property. Proper planning ensures compliance with IRS regulations and prevents costly mistakes.

  • Confirm property eligibility – The property must be held for investment or business purposes to qualify.
  • Choose a Qualified Intermediary (QI) – The IRS requires a QI to handle the funds and paperwork.
  • Understand the 45-day and 180-day deadlines – These strict time limits determine whether your exchange is valid.

Failing to prepare in advance could result in a failed exchange and an unexpected tax bill.

Real Estate Investor Planning a 1031 Exchange

Step 2: Sell Your Investment Property & Use a Qualified Intermediary

Once your property is sold, you must ensure that the proceeds do not go directly to you. Instead, the funds must be transferred directly to a Qualified Intermediary (QI). The QI holds the funds in a segregated, FDIC-insured account and will only release them when you purchase your replacement property.

The exchange agreement must be finalized before closing on the sale, as failing to set up a proper 1031 exchange beforehand will make the transaction taxable. The IRS does not allow investors to receive any funds from the sale, even temporarily, so using a QI is a mandatory part of the process.

Tax deferral benefits

Step 3: Identify a Replacement Property Within 45 Days

After your original property sells, the IRS gives you 45 calendar days to identify a replacement property. The identification must be submitted in writing to your QI, and changes cannot be made after the deadline. Investors can use one of three identification rules: the Three-Property Rule, which allows them to identify up to three properties regardless of value; the 200% Rule, which permits identifying more than three properties as long as their combined value does not exceed 200% of the original property’s sale price; or the 95% Rule, which allows an unlimited number of properties as long as at least 95% of the total value is purchased.

Failure to identify a replacement property within 45 days will result in a failed exchange, making the sale immediately taxable.

Selling an investment property

Step 4: Submit Your Replacement Property List to Your QI

The written identification of replacement properties must be submitted to your Qualified Intermediary before the 45-day deadline. Once submitted, changes or substitutions are not allowed after the deadline.

Pro Tip: It’s best to identify multiple properties in case your first choice falls through.

180-day closing deadline

Step 5: Complete the Purchase of Your New Property Within 180 Days

From the date your original property sells, you have 180 days to finalize the purchase of your identified replacement property.

  • The QI transfers exchange funds directly to the closing company for the purchase.
  • The replacement property must be of equal or greater value than the sold property to defer all taxes.
  • Any mortgage or financing on the original property must be matched or exceeded on the replacement property.

Missing the 180-day deadline disqualifies the exchange, and the sale becomes a taxable event.

1031 exchange mistakes

Step 6: Finalize the Exchange & Defer Capital Gains Taxes

Once the replacement property has been purchased and the transaction is complete, the 1031 exchange is officially closed, and capital gains taxes remain deferred. At this point, investors can continue holding the property to benefit from rental income, appreciation, and long-term investment growth. Some investors choose to repeat the 1031 exchange process multiple times, continuously deferring taxes and expanding their real estate portfolios. Others use the step-up in basis strategy by passing properties to heirs, potentially eliminating capital gains taxes altogether.

A successful 1031 exchange allows real estate investors to preserve more capital, reinvest in better properties, and maximize long-term wealth accumulation.

Finalize the Exchange & Defer Capital Gains Taxes

Avoid These Common 1031 Exchange Mistakes

Even experienced investors can make costly errors during a 1031 exchange. Avoid these common pitfalls:

  • Missing the 45-day or 180-day deadlines – The IRS does not grant extensions.
  • Receiving funds directly – Always use a Qualified Intermediary to hold the sale proceeds.
  • Identifying the wrong property type – The replacement must be like-kind real estate (not personal property).
  • Buying a lower-value property – If the replacement costs less, you may owe partial capital gains tax on the difference (boot).
  • Changing ownership structure – The same taxpayer or entity must sell and purchase the properties.
Avoid These Common 1031 Exchange Mistakes

Key Takeaways for a Successful 1031 Exchange

  • Understand IRS Rules – The 45-day identification rule and 180-day closing rule are non-negotiable.
  • Use a Qualified Intermediary – You cannot take possession of funds at any point.
  • Choose a Like-Kind Replacement Property – It must be equal or greater in value to avoid taxes.
  • Plan Ahead – Identify backup properties in case your first choice falls through.

By following these steps, real estate investors can defer capital gains taxes, reinvest in better properties, and build long-term wealth through the 1031 exchange process.

Key Takeaways for a Successful 1031 Exchange
Need Help With Your 1031 Exchange?

Need Help With Your 1031 Exchange?

Navigating a 1031 exchange requires expert guidance to ensure full compliance with IRS rules. If you have questions or need assistance, contact us today for professional support.