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Client Alert: “Let’s 1031 that building for another” Section 1031 Like-Kind Exchanges — What It Is and How It Works in Practice

• Tax Deferral Benefits: Section 1031 allows deferral of capital gains income taxes when exchanging interests in real estate, provided the properties are “like kind” and both held for investment or productive use.
• Real Property Requirement: Since 2017, only interests in real property qualify for 1031 exchanges; personal property does not.
• Handling Proceeds: Careful management of exchange proceeds is crucial to avoid taxable gains, especially concerning "boot" and debt discrepancies.
• Strict Timing Rules: Delayed exchanges must adhere to 45-day identification and 180-day closing deadlines.
• Role of Qualified Intermediaries: To prevent constructive receipt of proceeds, a qualified intermediary must manage the funds.
• Legal Guidance: Recent cases emphasize the importance of meeting deadlines and proper documentation to secure tax deferral benefits.

What Section 1031 does. Section 1031 lets you defer tax when you swap one investment or business real estate for another, as long as both are real property held for investment or productive use. Since 2017, only real property qualifies; personal property no longer does. U.S. real estate is not like-kind to property outside the U.S. The proceeds from a 1031 exchange must be handled carefully. If there’s any cash left over after the exchange (known as “boot”), it will be taxable as a capital gain. Similarly, if there’s a discrepancy in debt, the difference in liabilities is treated as boot and taxed accordingly. One of the main ways that people get into trouble with these transactions is failing to consider loans. If you don’t receive cash back but your liability goes down, then that also will be treated as income to you, just like cash.

What Is an Example of a 1031 Exchange?

Jane Doe owns an apartment building that’s currently worth $2 million, double what she paid for it seven years ago. She’s content until her real estate broker tells her about a larger condominium located in an area fetching higher rents that’s on the market for $2.5 million. By using the 1031 exchange, Jane could, in theory, sell her apartment building and use the proceeds to help pay for the bigger replacement property without having to worry about the tax liability straightaway. By deferring capital gains and depreciation recapture taxes, she is effectively left with extra money to invest in the new property.

Timing is strict in delayed exchanges. If you do not close on the new property the same day, two firm deadlines apply: identify the replacement property in writing within 45 days of the sale and receive it (close) within 180 days or by your tax return due date (with extensions), whichever comes first. To avoid “constructive receipt” of sale proceeds, most exchanges use a qualified intermediary to hold and disburse funds only for the replacement purchase.

How recent cases guide practice:

Delayed exchanges are allowed—but the deadlines rule. Courts paved the way for nonsimultaneous exchanges, and Congress later set the now familiar 45-day identification and 180-day closing deadlines.

Constructive receipt and missed deadlines defeat deferral. In Cook v. Cross, sale proceeds were accessible and there was no proof of timely 45-day identification or 180-day completion. If you can access the money before you receive the replacement property, the IRS treats it as a taxable sale. Keep all proceeds with the qualified intermediary and hit both deadlines.

Advisors must consider 1031—and damages have limits. In Little v. Cooke, the court found malpractice and fiduciary breaches when a partnership rushed a sale without properly evaluating a tax-deferred exchange. But investor level “tax damages” were not recoverable in a derivative suit because the partnership itself does not pay income tax; fee awards come from the common fund. The takeaway: evaluate 1031 as part of a sound sale process and align any claims with the entity’s posture.

Contract mechanics matter. In Saffold v. Conway, the purchase agreement built in flexibility for a 1031 exchange, including timing accommodations for the intermediary. Best practice is to include QI assignment language, “no cost or liability” acknowledgments and direct routing of proceeds to the intermediary. Lack of these signals worked against the taxpayer in Cook v. Cross.

Form versus substance remains a checkpoint. Courts will respect multiparty exchanges that truly swap real property and preserve continuity of investment. They will collapse transactions that, in substance, are cash sales or do not meet the “held for” requirement. Today’s brightline rules—real property only, 45/180-day deadlines, constructive receipt limits, and related party restrictions—frame that analysis.

Practical execution points

A successful exchange comes down to planning and process. Make sure the properties qualify (investment or business real estate; property held primarily for sale is out). Calendar the 45-day identification and 180-day closing dates. Avoid access to proceeds by assigning sale rights to a qualified intermediary and sending all net proceeds directly to that intermediary. Make the paperwork match, with express exchange and QI assignment language and consistent closing statements. Watch for boot and debt relief, which can trigger taxable gain.

Bottom line for clients

Section 1031 is a valuable tax deferral tool, but it is unforgiving on timing, control of proceeds and documentation. Recent cases reward careful execution and highlight risks around constructive receipt, missed deadlines and intermediary failures. Plan early, align your contracts and closing steps and keep tight control over the process to secure the intended deferral.

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The information contained here is not intended to provide legal advice or opinion and should not be acted upon without consulting an attorney. Counsel should not be selected based on advertising materials, and we recommend that you conduct further investigation when seeking legal representation.