How a 1031 exchange works

The mechanics, the timeline, and the pitfalls — in plain language.

The basic deal

Section 1031 of the Internal Revenue Code lets you sell investment real estate and reinvest the proceeds into other investment real estate without paying capital gains tax at the time of sale. The tax is deferred — not eliminated — until you eventually sell the replacement property without doing another exchange.

Two non-negotiable rules: you cannot touch the sale proceeds (they must be held by a Qualified Intermediary), and you must meet the IRS timelines below. Miss either and the transaction becomes a taxable sale.

The 45 / 180 timeline

Day 0 — Sale closes

Your relinquished property sells. Proceeds go directly to your Qualified Intermediary — you never receive them, or the exchange fails.

Day 45 — Identification deadline

You must identify replacement property in writing to your QI by midnight of day 45. Up to three properties (or more under the 200% rule). Calendar days, no extensions.

180

Day 180 — Closing deadline

Identified replacement property must close by day 180. If your tax return is due before then, the deadline is your return due date (so file an extension if needed).

What “like-kind” actually means

The 2017 Tax Cuts and Jobs Act narrowed 1031 to real property only — but within real estate, the like-kind test is broad. Any U.S. investment real estate qualifies as like-kind to any other U.S. investment real estate.

Raw land for an apartment building. A rental house for a self-storage facility. A retail strip for industrial flex. All like-kind. The only requirements are that both properties be held for investment or productive use in a trade or business, and both be located in the United States.

Your primary residence does not qualify. A flip you intended to resell quickly does not qualify. Foreign property does not qualify (but it is like-kind to other foreign property).

What you actually own

In a Hartley 1031, you own a direct interest in real property — typically a tenancy-in-common (TIC) interest, or a membership interest in an LLC treated as a disregarded entity or partnership for tax purposes. The exact structure depends on the property and is documented in the offering materials before you commit.

The key point: you have direct or pass-through ownership of real estate, which satisfies §1031 requirements. This is not a DST, not a REIT share, not a fund unit. You hold a piece of the underlying real estate.

Common pitfalls

·
Touching the proceeds. Even briefly. Even by accident. If the sale wire hits your account, the exchange is dead. The QI must receive funds at closing.
·
Missing day 45.The IRS does not grant extensions for the identification window. If you haven't identified by midnight of day 45, the exchange is over and you owe the tax.
·
No diligence on the replacement. A rushed identification under time pressure leads to bad property choices. Plan the replacement side before you list the relinquished property if you can.
·
DST by default.Most exchanges end up in a DST around day 40 because the seller ran out of time. DSTs work but are not the only path — a planned 1031 into operating real estate is usually the better outcome.
·
Forgetting depreciation recapture. The deferred tax includes capital gains AND depreciation recapture (currently taxed at up to 25%). If you skip the exchange, both are owed in the year of sale.

1031 into a development property

Common questions about whether development-stage real estate qualifies.

Does a 1031 into a development property still qualify?

Yes. You acquire an interest in real property — not a construction contract. At closing, you receive a fee simple or tenancy-in-common interest in land and improvements (or land with improvements underway). Under the 2017 Tax Cuts and Jobs Act, all U.S. real property is like-kind to all other U.S. real property, regardless of whether it's raw land, improved property, or a property under development. You're acquiring real estate, not funding construction.

What if construction isn't complete when the exchange closes?

That's fine. The like-kind test is met at the time of closing, not at completion of construction. You acquire an interest in real property — land plus whatever improvements exist at closing. Post-closing improvements are funded by the entity (using raised capital or financing), not by your exchange proceeds. This is structurally identical to acquiring an existing property that the new owner later renovates.

Don't you need Rev. Proc. 2000-37 for a development deal?

No. Rev. Proc. 2000-37 applies to 'build-to-suit' or 'improvement' exchanges where the exchanger directs the QI to use exchange proceeds to construct improvements on property they don't yet own. In our structure, you acquire an interest in an existing entity that owns real property. Exchange proceeds fund the acquisition of that interest — not construction. This is a standard deferred exchange under §1031(a), not a reverse or improvement exchange.

Have specific questions?

This page covers the mechanics. Your situation has specifics. Matt is a CPA — he can walk through your numbers and timeline.

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