Internal Revenue Code section 1031

A Section 1031 exchange, commonly known as a like-kind exchange, is a transaction under the 26 U.S.C. § 1031 of the Internal Revenue Code that allows owners of investment or business real estate to defer certain taxes when selling property and reinvesting the proceeds into other qualifying real property. It is most commonly used by real estate investors and property owners with low tax basis, for whom an outright sale would otherwise trigger capital gains tax and depreciation recapture. By exchanging rather than selling, taxpayers may defer recognition of these taxes while maintaining continuity of investment in real estate.

Section 1031 exchanges are frequently used as part of long-term real estate investment and estate-planning strategies. Because the exchange defers, rather than eliminates, tax liability by carrying forward the taxpayer’s adjusted basis, investors may continue exchanging properties over time. If the property is held until death, the deferred gain may be eliminated through a step-up in basis under U.S. tax law, a feature that has made Section 1031 exchanges particularly common among long-term property owners seeking to defer taxes across generations.

Before 2018, section 1031 also applied to certain exchanges of personal property, but the Tax Cuts and Jobs Act of 2017 limited nonrecognition treatment to exchanges of real property.

To qualify for section 1031 treatment, both the relinquished property and the replacement property must be real property held for productive use in a trade or business or for investment, and not held primarily for sale. Properties are of like kind if they are of the same nature or character, even if they differ in grade or quality; in general, most interests in real property in the United States are treated as of like kind to one another.

Real properties generally are of like kind, regardless of whether the properties are improved or unimproved. However, a real property within the United States and a real property outside the United States would not be like-kind properties. Generally, "like kind" in terms of real estate, means any property that is classified real estate in any of the 50 U.S. states or Washington, D.C., and in some cases, the U.S. Virgin Islands.

Taxpayers who hold real estate as inventory, or who purchase real estate for re-sale, are considered "dealers". These properties are not eligible for Section 1031 treatment. However, if a taxpayer is a dealer and also an investor, he or she can use Section 1031 on qualifying like properties. Personal use property will not qualify for Section 1031.

Taxpayers may wonder whether items such as equipment used on a property are included in the lump-sum sale of the property, and whether recognition of related gains may be deferred. Under Treasury regulation §1.1031(k)-1(c)(5)(i), property that is transferred together with the larger item of value that does not exceed 15% of the fair market value of the larger property does not need to be identified within the 45-day identification period, but still needs to be exchanged for like kind property to defer gain.

Cash to equalize a transaction cannot be deferred under Code Section 1031 because cash is not of like kind. This cash is called "boot" and the gain, to the extent of the receipt of this cash, is taxed at ordinary income tax rates.