1031 Exchanges: Taking Advantage of Like-Kind Exchange Rules

​For decades, real estate investors have leveraged the 1031 exchange as a powerful tool to defer capital gains taxes when reinvesting in like-kind properties. In recent years, proposals from the Biden administration suggested potential reforms that could have placed new limits on tax deferrals - particularly for high-value transactions.  

However, as of March 2025, no legislative changes have been enacted, and Section 1031 remains intact. While investors can still take advantage of full tax deferral, new IRS reporting requirements have been introduced to increase transparency. These changes mandate more detailed documentation of transaction timelines, property appraisals, and exchange compliance.

While the existing rules continue to provide significant tax advantages for investors, tax policy remains a topic of discussion, and future proposals could resurface. Staying informed about potential changes and understanding the nuances of IRS code 1031 is essential for investors looking to maximize their long-term real estate strategies.

In this guide, we’ll break down how 1031 exchanges work, explore key considerations, and discuss why this tax-deferral strategy remains a cornerstone of commercial real estate investing.

What is a 1031 Exchange?

A 1031 exchange, named after Section 1031 of the Internal Revenue Code, is one of the most powerful tools available to real estate investors looking to grow their portfolios while deferring capital gains taxes. By reinvesting proceeds from a property sale into a "like-kind" replacement property, investors can avoid immediate tax liability and continue building long-term wealth.

While 1031 exchanges apply to a wide range of real estate assets, they are particularly beneficial in the commercial sector, where properties such as office buildings, retail centers, multifamily complexes, warehouses, and industrial facilities regularly change hands. Investors who strategically utilize 1031 exchanges can reposition assets, consolidate holdings, or transition into new markets - all without triggering a taxable event.

However, 1031 exchanges come with strict rules, timelines, and tax considerations. Investors must fully understand how the process works to ensure compliance and maximize its benefits.

How Do 1031 Exchanges Work?

Essentially, a 1031 exchange allows investors to swap one investment property for another while deferring capital gains taxes. To qualify, both the relinquished and replacement properties must be held for business or investment purposes. This means personal residences do not qualify, but commercial properties such as shopping centers, apartment buildings, hotels, medical offices, and mixed-use developments are all eligible.

How Long Do You Have to Complete a 1031 Exchange?

When dealing with 1031 exchanges, the IRS requires investors to follow key deadlines. Missing these timeframes can result in immediate capital gains tax liability, making it essential to plan ahead and execute the exchange efficiently.

Understanding the 1031 Exchange 45-Day and 180-Day Windows

• The 45-Day Identification Period: Within 45 days of selling a property, the investor must formally identify up to three potential replacement properties.
• The 180-Day Exchange Period: The investor must close on one of the identified replacement properties within 180 days of selling the original asset.

If these 1031 exchange window regulations are not followed, the transaction no longer qualifies for tax deferral, and capital gains taxes become immediately due.

Can You Use a 1031 Exchange for Residential to Commercial Property?

Yes, investors can 1031 residential property into commercial property as long as both assets qualify as like-kind under IRS rules. This means the residential property must have been held for investment purposes, such as a rental home, rather than a primary residence.

For example, an investor could sell a single-family rental and reinvest in an office building, retail center, or multifamily complex, deferring capital gains taxes through a 1031 exchange. However, if the property was primarily used as a personal residence, it typically does not qualify.

To ensure compliance, investors should work with a Qualified Intermediary (QI) and carefully document how the relinquished and replacement properties meet investment-use requirements.

Reverse 1031 Exchanges: When Buying Comes First

Most investors follow a traditional 1031 exchange, selling their current property before acquiring a replacement. But what if an investor finds an ideal new property before selling their existing asset? In that case, a reverse 1031 exchange may be the answer.

A reverse exchange allows investors to purchase a replacement property first and sell their relinquished property later, but it requires careful structuring. Since IRS rules prohibit investors from owning both properties simultaneously, a specialized entity known as an Exchange Accommodation Titleholder (EAT) temporarily holds title to one of the properties during the exchange period.

This strategy can be beneficial in competitive markets where desirable properties may not stay available long enough for a standard 1031 exchange. However, reverse exchanges are more complex and require additional financing considerations, since investors must acquire the new property without using proceeds from their relinquished asset.

1031 Exchange Rules for New Construction

Not all newly built properties automatically qualify for a 1031 exchange, but investors can structure their deals to comply with IRS guidelines. One common strategy is the "Build-to-Suit" or "Construction 1031 Exchange", where an investor exchanges into a development-in-progress using an Exchange Accommodation Titleholder (EAT).

To qualify for a 1031 exchange for new construction:

• The investor must identify the property and planned improvements within the 45-day window.
• The new construction must be completed (or substantially improved) within the 180-day exchange period.
• The value of the replacement property, including improvements, must meet or exceed the relinquished property value.

Depreciation Recapture and Tax Risks

While a 1031 exchange defers capital gains taxes, it does not eliminate them entirely. One critical tax factor investors must consider is depreciation recapture, a tax levied on the portion of a property's value that has been depreciated over time.

Here’s how it all works under IRS code 1031:

• When an investor sells a commercial property, the IRS requires them to "recapture" the depreciation deductions they previously claimed.
• If the investor does not complete a 1031 exchange, the recaptured depreciation is taxed as ordinary income, typically at a 25% federal rate (plus applicable state taxes).
• By completing a 1031 exchange, investors defer not only capital gains tax but also depreciation recapture.

However, suppose an investor eventually sells their property without reinvesting in another 1031 exchange. In that case, all deferred capital gains and depreciation recapture taxes will come due (a fact that remains true under 1031 exchange rules in 2025). This is why many seasoned real estate investors continue using 1031 exchanges indefinitely, allowing their assets to grow tax-deferred for generations.

What are the 1031 Exchange Rules in 2025?

For investors considering deferring capital gains taxes through a 1031 exchange, staying on top of the latest regulations is a must. 

Here’s a quick breakdown of the basic 1031 exchange rules for 2025:

• Like-Kind Requirement – Both properties must be investment or business-use; personal residences don’t qualify.
• 45-Day Identification Period – Identify potential replacement properties within 45 days of selling.
• 180-Day Exchange Period – Complete the purchase of the replacement property within 180 days.
• Qualified Intermediary (QI) Required – Sale proceeds must be held by a QI to maintain tax deferral.
• Replacement Property Value Rule – The new property must be of equal or greater value to defer all taxes.
• Boot is Taxable – Any leftover cash or reduction in debt is subject to capital gains tax.
• Multiple Properties Allowed – Investors can acquire more than one property if they meet value and timing requirements.
• Debt & Equity Must Match – Any debt paid off must be replaced with equal or greater debt/equity.
• Reverse 1031 Exchanges – Buying first is allowed but requires an Exchange Accommodation Titleholder (EAT).
• Depreciation Recapture Applies – Taxes on depreciation are deferred but not eliminated.

Stricter IRS Reporting – 2025 rules require enhanced documentation and transaction tracking for compliance.

Benefits of 1031 Exchanges for Commercial Property Sellers

A 1031 exchange is more than just a tax deferral tool - it’s a strategic way for investors to maximize returns, expand portfolios, and optimize real estate holdings. 

Here’s how:

• Tax Deferral for Greater Buying Power: By deferring capital gains taxes, investors retain more capital to reinvest in higher-value or higher-performing properties, accelerating long-term wealth growth.
• Portfolio Growth & Diversification: A 1031 exchange allows investors to shift from one asset class to another, such as exchanging a small retail strip for a larger industrial property, or consolidating multiple assets into one higher-value property.
• Geographic Flexibility: Investors can relocate capital to stronger markets, moving from declining areas to high-growth regions where demand and rental yields are higher.
• Wealth Building Through Compounding: By repeatedly leveraging 1031 exchanges, investors can continually upgrade their portfolio, scaling from smaller properties to more lucrative assets while deferring taxes indefinitely.
• Estate Planning & Legacy Benefits: 1031 exchanges can be used as a long-term estate planning tool, allowing investors to pass properties down to heirs with a stepped-up cost basis, effectively eliminating capital gains taxes at the time of inheritance.

Example of a 1031 Like-Kind Exchange

Here’s a closer look at a real-world example of how a 1031 exchange works:

Scenario: Selling an Office Building

• Original Purchase Price: $1 million
• Current Sale Price: $2 million
• Capital Gains Tax (20% on $1M gain): $200,000

Option 1: Selling Without a 1031 Exchange

1. Investor sells for $2 million
2. Pays $200,000 in capital gains tax
3. Left with $1.8 million to reinvest

Option 2: Using a 1031 Exchange

1. Investor sells for $2 million
2. Reinvests the full amount into a retail shopping center
3. No capital gains tax due at the time of exchange

How a 1031 Exchange Benefits the Investor in this Scenario

• Maximized Reinvestment: Keeps the full $2M working for the investor
• Increased Buying Power: Ability to purchase larger or higher-value properties
• Tax Deferral: Allows for compounded portfolio growth over multiple exchanges
• Portfolio Diversification: Flexibility to transition between asset classes (e.g., office to retail)

Final Thoughts on 1031 Exchanges

A 1031 exchange remains one of the most powerful tools for commercial real estate investors looking to defer capital gains taxes, reinvest strategically, and grow their portfolios. By understanding the key rules, deadlines, and investment opportunities, investors can make informed decisions that maximize their returns while staying compliant with IRS regulations.

Navigating a 1031 exchange successfully requires the right resources, insights, and expert support - that’s where Crexicomes in. With industry-leading tools for CRE research, due diligence, and transaction management, Crexi empowers investors to market, analyze, and trade commercial properties with confidence. 

Explore smarter investment opportunities and find your next deal with Crexi.