How a 1031 Exchange Works. And Why Every Real Estate Investor Should Know.
When you sell an investment property, the IRS is usually right there with its hand out. But with a properly executed 1031 exchange, you can defer capital gains taxes and reinvest 100% of your sale proceeds — giving your money more time to grow.
So how does it actually work?
Let’s walk through the process step-by-step so you can see what’s involved, where most investors make mistakes, and how you can use a 1031 exchange to your advantage.
Step 1: Sell the Property — But Don’t Take the Cash
Once you’ve closed on the sale of your investment property — known as the relinquished property — the clock starts ticking.
You can’t take possession of the sale proceeds. If you do, it counts as a taxable sale. Instead, the money must be placed directly into a special escrow account administered by a third-party known as a Qualified Intermediary (QI).
Think of this account like a bridge. It holds your funds temporarily until you’re ready to buy your replacement property.
Step 2: Identify New Properties (You’ve Got 45 Days)
From the date of closing, you have 45 calendar days to formally identify which property (or properties) you plan to buy next.
This list must be in writing and follow specific IRS rules. Most investors choose one or two potential replacement properties, but there are three identification rules you can use:
The Three Property Rule: You can identify up to three properties, regardless of value.
The 200% Rule: You can identify more than three properties, as long as their total fair market value doesn’t exceed 200% of what you sold.
The 95% Rule: You can identify any number of properties if you end up acquiring 95% of their total value.
Miss this step or file it late, and your entire exchange can be disqualified.
Step 3: Purchase the Replacement Property (Within 180 Days)
Next, you’ll need to complete the purchase of your new property — known as the replacement property — within 180 calendar days of the original sale. That includes weekends and holidays.
The funds held in trust can then be used as earnest money or to complete the transaction, assuming all IRS conditions have been met.
Fail to close in time? The funds are released, and you’ll owe capital gains taxes on the full sale.
Timing Is Everything
The 45-day identification window and 180-day completion rule are hard deadlines. There are no extensions. If either milestone is missed — even by a day — the IRS treats the entire sale as taxable.
That’s why it’s critical to work with a trusted QI and a team that understands the nuances of 1031 exchanges.
Simplifying the Process
At ICON1031, we help investors navigate the rules, timelines, and paperwork — and we often recommend Delaware Statutory Trusts (DSTs) as replacement property options for those who want income without landlord responsibilities.
Whether you’re looking to reinvest, retire, or simplify, a properly executed 1031 exchange can help you do it smarter.
Schedule a free consultation to learn how we can help.
