1031 Exchange Real Estate Rules: Common Questions Answered

Understanding 1031 exchange real estate rules is essential for any property investor looking to defer capital gains taxes, but with frequent misconceptions and recent legislative changes, knowing exactly what qualifies as like-kind exchange property isn’t always straightforward.

This guide answers the most common questions about qualifying property types, permitted uses, and how development activity affects 1031 exchange eligibility.

JTC’s team of 1031 exchange experts receives a lot of questions about IRC Section 1031, which outlines rules for the deferral of capital gains taxes through like-kind exchanges. This part of the tax code has come under fire from critics, and there is a lot of misinformation out there.

“Exchanges are often misunderstood as another tax strategy used by the wealthy or corporate companies as a way to avoid paying taxes, when in actuality the transaction is more commonly used by the average real estate investor. From job creation, capital relocation, and the potential to revitalize communities, 1031 exchanges offer more to the U.S. than meets the eye. Education for all parties involved will be key to the continued success of the program.” – Justin Amos, JTC National Sales Manager & Account Executive

Though like-kind exchanges have been a part of the Internal Revenue Code since 1921, there have been some changes in the last decade regarding what types of property can qualify. To better understand the current rules and what property types can be used in a 1031 exchange, here are the answers to some frequently asked questions about 1031, real estate, developing land, vacation homes, and more.

Consult our guide to 1031 exchange terminology

Why are 1031 exchanges limited to real estate?

IRC Section 1031 only applies to real property, but this wasn’t always the case. Prior to 2018, many types of business property could be used as part of a like-kind exchange. The Tax Cuts & Jobs Act of 2017 altered Section 1031 so that it would “apply only to qualifying exchanges of real property.”

The result of this modification is that 1031 exchange treatment for “personal property” exchanges — such as the buying and selling of tangible depreciable property, including aircraft, automobiles, and heavy equipment; or of intangibles, like patents — which had long been eligible under Section 1031, would no longer be allowed.

Admittedly, for the average exchanger, this change won’t make much of a difference: commercial and investment real estate already made up the majority of 1031 exchange property. So long as real property is held for business or investment purposes, it can qualify as “like kind” under Section 1031 and be used in an exchange. That means you can exchange any type of real estate for any other, including single or multi-family rental properties, commercial office or retail spaces, warehouses, farmland, factories, mineral rights, Delaware Statutory Trusts (DSTs), and other property types, so long as they are considered real property and held for business or investment use.

Download our “How to Perform a 1031 Exchange” factsheet

Can You Exchange Multiple Properties in a Single 1031 Exchange?

A typical 1031 exchange involves selling one relinquished property and purchasing another replacement property. However, selling one property and acquiring several replacement properties (or selling several properties and buying one replacement property) is also allowed, assuming the exchange follows all designated guidelines.

Although IRC Section 1031 enables a taxpayer to acquire multiple properties, it is important to remember that the 1031 identification rules apply differently to multi-property exchanges. These types of uncommon exchange scenarios can be complicated, which is why working with a Qualified Intermediary (QI) who is experienced with handling all types of exchanges is the best way to increase the likelihood of a successful exchange.

Learn about Qualified Intermediary’s and why every exchange is required to have one

When does vacation home qualify for a 1031 exchange?

Taxpayers buying and selling vacation homes may assume their properties do not qualify for a 1031 like-kind exchange. However, in cases where vacation property has been primarily held for investment or business use, with only occasional personal use, it may be possible to defer capital gains taxes through a 1031 exchange.

Some properties may be used for both personal and business purposes. For example, taxpayers who own vacation property may rent  the property to others for the majority of the year, but still occasionally use it for personal enjoyment. To account for these situations, the IRS issued Revenue Procedure 2008-16, which provides a safe harbor allowing dwelling units to qualify despite limited use for personal purposes.

Safe Harbor Requirements (Rev. Proc. 2008-16): To fulfill the safe harbor requirements and qualify for a 1031 exchange, the taxpayer must hold the relinquished or replacement vacation property for at least two years directly preceding or following the exchange. In each of the two 12-month periods preceding or following the exchange, the taxpayer must rent the property at fair market value for at least 14 days. The taxpayer may use the property for personal purposes for no more than 10% of the number of days the property was rented within the 12-month period, or 14 days, whichever is greater.

Both the relinquished and replacement vacation properties being exchanged must meet the productive use and safe harbor requirements. Failure to comply with these requirements could jeopardize the outcome of the exchange and result in significant capital gains tax liability.

Read our guide to how long a property must be rented before a 1031 exchange

Can You Develop Land and Then Use It as a Relinquished Property in a 1031 Exchange?

Short answer: typically, no — but with careful planning, it may be possible.

Usually, real estate that has been acquired to develop and then sell does not qualify for a 1031 exchange. As mentioned earlier, 1031 applies to real property that is “held for productive use in a trade or business, or for investment, and that is not held primarily for sale.”

What matters is intent: if you purchase undeveloped land with the intention of holding that asset as it appreciates in value, then it is held “for investment” and could qualify. But if you purchase it with the intention of building on it and then selling it, then it is being held “primarily for sale” and wouldn’t qualify.

If, after developing the land, the owner were to rent the property (or units built on the property) for a period of time, then it could potentially qualify.

Ultimately, whether a property can be sold as part of a 1031 exchange depends upon what the seller intended to do with it when they bought the property. It’s also important that the seller’s actions following their acquisition of the undeveloped land be consistent with their intent. Exchangers are encouraged to consult with their tax and legal advisors to determine whether a developed property would meet the qualified use requirements of an exchange.

Certain individuals are designated as dealers of real estate, meaning their primary vocation is the buying and selling of property. For these individuals, it is more difficult to establish intent to hold a property for business or investment purposes. To learn more, read our blog on the subject.

Have further questions about 1031 exchange real estate rules?

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