What is a 1031 Exchange?

Posted on Jul 18, 2025 by Griswold LaSalle Staff

What is a 1031 Exchange?

A 1031 exchange allows taxpayers to swap one business or investment property for another similar property of equal or greater value. This powerful tax strategy can be used to defer capital gains tax when selling a business or investment property. The deferral of capital gains taxes allows taxpayers to leverage their total equity into higher-value properties. ¹Additionally, if the replacement property is held until death, heirs may receive a “step-up in basis,” potentially eliminating deferred gains.²

1031 exchanges can offer significant financial benefits; however, the internal Revenue Service (IRS) imposes strict procedural requirements.¹ This blog will break down the procedural and timing requirements involved in executing a successful 1031 exchange in California.

IRC Section 1031 Explained

A 1031 exchange, named after Section 1031 of the U.S. Internal Revenue Code, is a real estate transaction in which taxpayers can defer paying capital gains tax when they sell an investment property and reinvest the proceeds into another qualifying property. Section 1031 specifies that all proceeds from the sale must be reinvested into a “like-kind property of equal or greater value within a specific timeframe.¹

The “like-kind” requirement means that both properties must be held for investment or business use. Properties held for resale or personal use, such as primary residences, do not qualify for a 1031 exchanges.³ Additionally, to preserve the tax deferral, the taxpayer must not receive any of the sale proceeds during the process. Instead, a Qualified Intermediary (QI) must hold and manage the funds throughout the exchange. Once the exchange is complete, the taxpayer must report the transaction using IRS Form 8824.⁴

Exchange Process Overview

The process for executing a 1031 exchange involves two primary steps. First the taxpayer must sell the original property (“relinquished” property) and identify another “like-kind” property (“replacement” property).¹ Then, the taxpayer must acquire the replacement property and report the transaction to IRS.¹

While this process seems straightforward, success hinges on the acquisition of a Qualified Intermediary (QI) and adherence to two strict timing deadlines that begin the moment the original property is sold.⁴

Essential Party: Qualified Intermediary (QI)

During a 1031 exchange, the taxpayer cannot access the sale proceeds. Instead, a Qualified Intermediary (QI) must be hired to draft an exchange agreement, hold the sale funds, and acquire the replacement property on behalf of the taxpayer. The QI must be a neutral third party and cannot be the taxpayer. The QI must be a neutral third party and cannot be the taxpayer’s attorney, broker, or accountant.³

Timing Deadlines

There are two timing deadlines which must be strictly followed. The first is a 45-day identification period and the second is a 180-day exchange period.¹

After selling the relinquished property, the taxpayer has exactly 45 days to identify potential replacement properties. The identification must be made in writing and delivered to the QI within this 45-day window.¹ Missing the 45-day deadline will disqualify the entire exchange.⁵

The second deadline is the 180-day exchange period.⁶ The taxpayer must close escrow on the replacement property within 180 days of selling the relinquished property.⁶ Both the 45-day and 180-day deadline run concurrently, meaning that taxpayers wishing to execute a 1031 exchange have a total of 180 days from the date of the original sale to identify and close on the replacement property.⁶

Special Rules for California Taxpayers

California generally follows the federal 1031 rules but imposes some unique requirements for its residents. If the replacement property is later sold in a taxable transaction.⁸ This means that California taxpayers need to consider state tax consequences carefully when acquiring out-of-state replacement properties.

Conclusion

A 1031 exchange can be a beneficial tool for deferring capital gain tax, building wealth, and growing your real estate portfolio. However, success depends on closely following the IRS’s procedural and timing rules, With the help of a Qualified Intermediary and carefully planning, taxpayers can take full advantage of this strategic tax benefit.

Work Cited
  1. Internal Revenue Service, 26 U.S.C. § 1031, accessed June 13, 2025, https://codes.findlaw.com/us/title-26-internal-revenue-code/26-usc-sect-1031/.
  2. . Internal Revenue Service, 26 U.S.C. §1014, accessed June 13, 2025, https://codes.findlaw.com/us/title-26-internal-revenue-code/26-usc-sect-1014/
  3. Internal Revenue Service, Like-kind exchanges – Real Estate Tax Tips, accessed June 13, 2025, https://www.irs.gov/businesses/small-businesses-self-employed/like-kind-exchanges-real-estate-tax-tips.
  4. Internal Revenue Service, Instructions for Form 8824, accessed June 13, 2025, https://www.irs.gov/instructions/i8824.
  5. Carlton v. United States, 385 F.2d 238, 242 (5th Cir. 1967), accessed June 13, 2025.
  6. Internal Revenue Service, 26 C.F.R. § 1.1031 (k)-1, accessed June 13, 2025, https://www.ecfr.gov/current/title-26/chapter-I/subchapter-A/part-1/subject-group-ECFRbf83dcc4bd89326/section-1.1031(k)-1.
  7. California Franchise Tax Board, Instructions for Form FTB 3840, accessed June 13, 2025, https://www.ftb.ca.gov/forms/2023/2023-3840-instructions.html.
  8. California Revenue and Taxation Code, Cal. Rev. & Tax Code §18032, accessed June 13, 2025, https://codes.findlaw.com/ca/revenue-and-taxation-code/rtc-sect-18032/