1031 Exchanges Simplified: How to Defer Taxes on Sales (1031 Tax Exchange Explained)

Isaac Robles
Sep 4
4 min read

If you’re a real estate investor, you’ve probably heard the term “1031 exchange” tossed around. It sounds complicated, but the basic idea is simple: a 1031 exchange lets you sell one investment property and buy another while deferring the capital gains taxes you would normally owe.

In other words, it’s a powerful tool for building wealth over time... assuming you know the rules.

This guide breaks down 1031 exchanges in plain English, with examples and key rules every investor should understand.

Arrow points from a small house to a tall apartment building at sunset, symbolizing moving or growth. Sky is warm and calm.

What?: What Is a 1031 Exchange?

A 1031 exchange (named after Section 1031 of the Internal Revenue Code) allows investors to “swap” one investment or business property for another without immediately paying capital gains taxes. Instead, those taxes are deferred, which means more of your money stays working for you in the next deal.

Capital gains tax is the tax you pay on the profit when you sell an investment for more than you bought it for.

Key: Think of it like hitting the snooze button on your taxes. You don’t erase them, but you push them off to a later time. Eventually, if you sell without reinvesting, you’ll owe the taxes. By rolling your "gains" forward, you can keep growing your portfolio faster.

Who?: Who Can Use a 1031 Exchange

1031 exchanges are available to anyone who owns real estate held for investment or business purposes. That includes individual investors, partnerships, corporations, and even some trusts.

The key is that the property cannot be your personal residence or vacation home. It must be property used to generate income or for business use.

For Example: A landlord with a rental duplex can exchange it for a small office building, or a company can trade raw land for a warehouse. Everyday homeowners, however, cannot use 1031 for their primary home.

Why?: Why Investors Use 1031 Exchanges

Defer Taxes: Keep your capital working for you instead of sending a large check to the IRS.
Grow Faster: Reinvest 100% of your equity into larger or better-performing properties.
Diversify: Exchange into different types of properties or new markets.
Consolidate or Upgrade: Move from several smaller properties into one larger one (or vice versa).

In short, investors use 1031 exchanges because they get to keep more of their money invested, move into bigger or better properties, and build wealth over time.

A Simple Example

Imagine you bought a duplex years ago for $200,000, and today it’s worth $400,000. If you sell outright, you could owe capital gains taxes on the $200,000 profit. That would end up being tens of thousands of dollars out of your pocket.

With a 1031 exchange, you sell the duplex, but instead of paying taxes, you roll the $400,000 into a new four-unit property worth $600,000. You’ve deferred taxes, increased your cash flow, and upgraded your portfolio. You lost no equity to taxes.

How?: Basic Rules to Follow

To qualify for a 1031 exchange, the IRS has specific requirements:

Investment Properties Only: Both the property you sell (the “relinquished property”) and the one you buy (the “replacement property”) must be for investment or business use. It cannot be for anything personal.
Like-Kind Requirement: Properties must be 'of the same nature or character', but they don’t have to be identical. For example, you can exchange an apartment building for a strip mall, or raw land for a rental property. “Like-kind” is broader than most people think. Picture this as trading within the same league. You can switch positions (types of property) as long as you’re still playing the same sport (investment real estate).
Strict Timelines: You must identify your replacement property within 45 days of selling your old one, and you must close on it within 180 days. These deadlines exist so the IRS can make sure exchanges happen quickly and stay fair.
Use a Qualified Intermediary: You can’t touch the proceeds from the sale. A neutral third party (the intermediary) holds the funds until they’re used for the purchase. Think of this person as a trusted middleman who keeps you from accidentally breaking IRS rules by touching the money yourself.
Equal or Greater Value: To fully defer taxes, the new property must be of equal or greater value than the one you sold, and you must reinvest all proceeds. If your replacement property is smaller, you’ll pay taxes on the difference... this is called “boot.”

How?: Pitfalls to Avoid

Missing deadlines: 45 days goes by fast. Always start scouting replacement properties early.
Trying to DIY: The IRS requires a qualified intermediary. Don’t try to handle the funds yourself.
Personal property confusion: Your vacation cabin or primary home doesn’t qualify.
Partial exchanges: If you take some cash out (“boot”), you’ll pay taxes on that portion.

1031 Tax Exchange Explained: Quick Summary Table

Question:	Answer:	Why It Matters:
What is a 1031 Exchange?	Selling one investment property and buying another without paying taxes right away	Lets you keep more money working in your next deal
Who Can Use It?	Available to investors, businesses, and some trusts with property used for income	Everyday homes don’t count
Why Use It?	Helps investors defer taxes & grow faster.	Builds wealth faster and opens more opportunities
Example	Duplex bought for $200k, sold for $400k, rolled into a $600k property	Demonstrates upgrading without losing equity to taxes

A 1031 exchange is one of the most effective ways to keep your money working for you, grow your portfolio, and move into better opportunities without losing equity to taxes right away.

The key is understanding the rules and avoiding the common mistakes that trip up new investors. Hopefully you've found this explanation of the 1031 tax exchange explained in an understandable way.

If you’re thinking about selling an investment property in Wisconsin, let’s connect. As your local real estate expert, I’ll walk you through the process, connect you with trusted professionals, and help you find the right replacement property so you can maximize your return.

Disclaimer: This article is for educational purposes only and does not constitute tax or legal advice. Always consult with a CPA, tax advisor, or attorney about your specific situation.