1031 Exchanges Explained: A Practical Guide for Real Estate Investors

If you’ve owned investment real estate for any length of time, you’ve probably heard about 1031 exchanges. They’re often described as one of the most powerful tax tools available to real estate investors — and when used correctly, that’s true. A 1031 exchange allows you to sell an investment property and reinvest the proceeds into another qualifying property while deferring capital gains taxes, keeping more of your equity working for you instead of going to the IRS.

That said, 1031 exchanges aren’t magic, and they aren’t right for every situation. They come with strict rules, tight timelines, and tradeoffs that investors should understand before relying on them as part of a long-term strategy. At Wisco, we believe clarity beats complexity every time. This guide breaks down how 1031 exchanges work, when they make sense, and what investors should watch out for — all in straightforward terms.

What Is a 1031 Exchange?

At its core, a 1031 exchange is a tax-deferment strategy outlined in Section 1031 of the Internal Revenue Code. It allows investors to defer paying capital gains taxes when they sell an investment property, as long as the proceeds are reinvested into another qualifying property.

The key word here is defer. A 1031 exchange does not eliminate taxes forever. Instead, it allows you to postpone them, often for many years, by continuously reinvesting into new properties. For long-term real estate investors, this can significantly accelerate portfolio growth.

Why 1031 Exchanges Matter for Investors

When you sell an investment property outright, you may owe:

• Federal capital gains taxes
• State capital gains taxes
• Depreciation recapture

Depending on your situation, that tax bill can easily take 20–30% (or more) of your gains. By using a 1031 exchange, those dollars stay invested — giving you more buying power for your next property.

How 1031 Exchanges Work in Practice

While the concept is simple, executing a 1031 exchange requires careful planning.

Step 1: Sell Your Relinquished Property

The property you’re selling is known as the relinquished property. It must be held for investment or business purposes — primary residences do not qualify.

Importantly, you cannot take possession of the sale proceeds. The funds must be held by a qualified intermediary, a third party who facilitates the exchange.

Step 2: Identify Replacement Properties

Once your property closes, the clock starts ticking. You have 45 days to identify potential replacement properties in writing. This identification period is strict and non-negotiable.

Most investors use one of these common identification rules:

• Identify up to three properties, regardless of value
• Identify more than three properties, as long as their combined value does not exceed 200% of the sold property’s value

Step 3: Close on the Replacement Property

You must complete the purchase of one or more replacement properties within 180 days of selling your original property (or by your tax filing deadline, whichever comes first).

Miss the deadline, and the exchange fails — triggering the taxes you were hoping to defer.

What Qualifies for a 1031 Exchange?

One of the most common misconceptions about 1031 exchanges is that properties must be identical. In reality, the IRS uses a broad definition of like-kind.

Like-Kind Property Explained

For real estate, like-kind simply means:

• Both properties are real estate
• Both are held for investment or business use

That means you can exchange:

• A single-family rental for an apartment building
• A small multifamily property for a larger one
• A retail property for industrial or office space

This flexibility is one reason 1031 exchanges are so widely used.

Properties That Do Not Qualify

Not everything qualifies for a 1031 exchange. Common exclusions include:

• Primary residences
• Fix-and-flip properties held primarily for resale
• Property held for personal use

Intent matters. The IRS looks at how the property was used, not just how it’s labeled.

Common Reasons Investors Use 1031 Exchanges

At Wisco, we see investors use 1031 exchanges for a few consistent reasons.

Scaling Into Larger Properties

Many investors start with smaller properties and use 1031 exchanges to scale up over time. By deferring taxes, they can roll equity from multiple smaller assets into a larger, more efficient property.

Improving Cash Flow

A 1031 exchange can allow investors to trade out of low-cash-flow properties into assets with stronger income potential — without losing capital to taxes in the process.

Reducing Management Intensity

Some investors exchange from hands-on properties into more passive investments, such as professionally managed multifamily or DST structures (where appropriate). The exchange becomes a tool for lifestyle design, not just tax planning.

Geographic Diversification

Investors can use 1031 exchanges to shift capital into new markets or consolidate holdings into areas they understand better.

Key Rules Investors Must Follow

The IRS is very clear about how 1031 exchanges must be executed.

Equal or Greater Value Rule

To fully defer taxes, the replacement property must be of equal or greater value than the relinquished property. Any reduction in value may result in taxable “boot.”

Reinvest All Proceeds

All net proceeds must be reinvested. Cash taken out of the transaction is typically taxable.

Use a Qualified Intermediary

You cannot hold the funds yourself, even temporarily. A qualified intermediary is required, and they must be engaged before the sale closes.

Common Mistakes With 1031 Exchanges

Even experienced investors can run into trouble with 1031 exchanges.

Waiting Too Long to Plan

A successful exchange starts before the property goes on the market. Waiting until after closing often limits options and increases risk.

Misunderstanding Timelines

The 45-day and 180-day deadlines are unforgiving. Missing them by even one day can invalidate the exchange.

Assuming 1031 Exchanges Are Always the Best Option

Deferring taxes isn’t always the optimal move. In some cases, paying taxes and redeploying capital differently can make more sense.

Are 1031 Exchanges Right for Every Investor?

Not necessarily. While 1031 exchanges can be powerful, they should fit into a broader investment strategy.

For investors nearing retirement, those looking to simplify, or those with losses to offset gains, alternatives may be worth considering. The key is understanding that 1031 exchanges are a tool — not a requirement.

The Wisco Approach to 1031 Exchanges

At Wisco, we don’t treat 1031 exchanges as a checkbox. We view them as part of a long-term, disciplined approach to real estate investing. Our focus is on helping investors preserve capital, manage risk, and build steady wealth backed by real assets.

If you’re considering a 1031 exchange, we encourage you to consult with qualified tax and legal professionals — and to think carefully about how the next property fits into your broader goals.

Final Thoughts on 1031 Exchanges

When used thoughtfully, 1031 exchanges can be one of the most effective ways to compound wealth through real estate. They reward patience, planning, and long-term thinking — the same principles that guide our approach at Wisco.

Clarity matters. And with the right structure and guidance, 1031 exchanges can help keep your capital working where it belongs: in real assets, building real value over time.

Any questions? Contact us for more information.

A Final Word on Professional Guidance

IRS rules around 1031 exchanges can be nuanced, particularly for more complex situations. Before moving forward, we strongly encourage investors to consult experienced tax and legal professionals to ensure the strategy is structured correctly and aligned with their broader goals.