A 1031 Exchange allows commercial real estate investors to defer capital gains taxes by reinvesting sale proceeds into like-kind property. Careful planning and professional guidance is essential to leverage this mechanism within IRS strict timelines for repositioning assets.
More than a tax deferral tool, 1031 Exchange is a proven way for portfolio growth, tax savings, and long-term wealth building, especially when combined with other tools such as cost segregation (100% bonus depreciation under 2025 OBBBA), and tax basis step-up as part of inheritance strategy.
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A 1031 Exchange or a Starker Exchange, named after Section 1031 of the Internal Revenue Code, permits the deferral of capital gains taxes when investors sell commercial real estate and reinvest in a property of equal or greater value that is considered “like-kind” (IRS, 2023). Instead of paying federal taxes on the gains immediately, investors can defer the taxes and use the full sales proceeds to acquire replacement property, compounding investment potential.
In addition to tax deferral, 1031 Exchange is also a vehicle for upgrading or diversifying property types, or expanding geographic reach. According to the California Lawyers Association, the 1031 exchange mechanism has become a cornerstone for real estate investors looking to maximize capital while deferring taxation (CalLawyers.org, 2022).
What happens when the proceeds of the sale aren’t used 100% to purchase the replacement property? Will the IRS tax the leftover “boot” portion and how much? In Part 2 coming up next, we will explain and discuss boot and the tax consequences if the entire proceeds are underutilized. We will also provide a step-by-step guide on how to successfully execute a 1031 Exchange. Stay tuned.
The IRS sets strict guidelines:
Like-Kind Requirement: Properties must be intended for productive use in business, or commercial investment and “of similar nature or character, though not necessarily identical in grade or quality” (Cornell Law School, 2022). For example, raw land can be exchanged for an office building. even a residential home can be exchanged if it is initially rented out as an investment property.
45-Day Identification Period: Within 45 days of selling the original property or relinquished property (the “down leg” property), investors must identify, in writing, potential replacement property to be purchased (the “up leg” property) with 1031 Exchange (IRS, 2023).
There are three (3) identification options:
180-Day Completion Period: Begins on the date the relinquished (sold) property closes, the investor has 180 calendar days to complete the acquisition of the replacement property for 1031 exchange.
Qualified Intermediary Requirement: Proceeds must be held by a third-party qualified intermediary, not the investor, to preserve tax-deferred status (Fidelity, 2023).
Failure to meet these deadlines or rules results in immediate taxation.
Using 1031 Exchange strategies can support both short-term tactical moves, as well as long-term strategic positioning and portfolio growth in commercial real estate.
The 1031 exchange rule can only defer paying federal capital gains tax up until you sell your exchanged property during your lifetime. You owe Uncle Sam capital gain taxes upon sale.
On top of the capital gains tax, the depreciation deductions you claimed previously that have lowered your tax basis before the sale, will be clawed back (“depreciation recapture”) by the IRS, if you sell.
UNLESS you pass on the property to your heirs upon death: Your heirs who inherit the property can use a new tax basis step-up that can erase all the deferred capital gains tax AND eliminate the depreciation recapture as well. The heirs start fresh as if zero depreciation was ever claimed. In 2025, the federal estate exemption is $13.99M per individual, and will increase to $15M in 2026.
Example: you bought a property for $500k, exchanged a few times, and now it’s worth $2M. At death, your heirs inherit with a $2M basis. If they sell at $2M, there is zero federal capital gains tax. Zero depreciation recapture.
Let it be said again: After the owner dies, the property receives a “step-up in basis” to market value as of the date of death, eliminating both federal deferred capital gains and depreciation recapture for the heirs. The heirs start with a new basis as if zero earlier depreciation or gain had accrued; if they sell at the stepped-up value, there is zero federal taxable gain nor depreciation recapture to pay.
HOWEVER, there is still estate tax and different state inheritance taxes, which will be discussed in Part 2 in the next blog.
1031 Exchanges have risks and challenges:
– Tight deadlines can lead to hasty decisions and suboptimal acquisitions, if unplanned ahead, can create pressure, stress, and anxiety.
– Transaction fees and intermediary costs can erode gains.
– If replacement properties underperform, the investor still carries the deferred tax liability into the future, if and when the replacement property will be sold.
– Potential changes to IRS 1031 Exchange rules and legislative changes in estate tax, state-level taxes, or other related future law changes could still take a bite when they take place.
Careful due diligence, long-term strategic planning, and expert guidance are essential to balancing risk with opportunity, to ensure the best possible chance of flawless exchanging into bigger, better, or higher valued properties.
The 1031 Exchange remains one of the most powerful tools available to commercial real estate investors, but only when executed with discipline and the guidance of a seasoned commercial real estate advisor.
Tax deferral improves cash flow that compounds your investment power. It also provides flexibility to adapt, diversify, and change portfolios in response to market conditions.
It is best to navigate the strict IRS rules with experienced advisors’ professional guidance due to the sizable financial stakes. To avoid an expensive misstep, it is important to work with experienced commercial real estate advisors such as the Ivy Group, qualified intermediary, tax advisors, and legal professionals to accomplish a seamless 1031 exchange.
Thinking about repositioning your portfolio? Is now the right time to explore whether a 1031 Exchange aligns with your goals? If you’re weighing whether a 1031 Exchange fits your investment strategy, please contact us to build your future-proof real estate portfolios, with 1031 Exchange as one lever.
Stay tuned for more information on Boot Taxes and related estate taxes at both the federal and state levels in Part 2.
A commercial real estate transaction is a multi-faceted process that involves factors such as investment insights, financing, alignment of properties with clients’ specific needs, market analysis, savvy negotiation, communication, tax planning, and other related areas such as accounting, law, technology, and engineering.
When you need to sell, buy, or lease, the Ivy Group is ready to help you reach your goals with more than 100 years of combined experience and expertise. Contact us with your next real estate needs.
Disclaimer:
The above and all information shared as blogs and case studies are for general education only, not as tax, legal, or investment advice. Please seek professional advice from tax, CPA, legal, and other professionals.
Copyright ©️ 2025 by Tim Vi Tran, SIOR, CCIM. All rights reserved.
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