A 1031 exchange — named after Section 1031 of the U.S. Internal Revenue Code — is a tax-deferral strategy that allows real estate investors to sell one investment property and reinvest the proceeds into another “like-kind” property without immediately paying capital gains taxes on the profit.

In real estate, “like-kind” is very broad — it means any real property held for investment or business purposes can be exchanged for another of the same general type.

Examples:

Apartment building → Retail center

Vacant land → Industrial warehouse

Single-family rental → Multifamily complex

Sell an investment property

You sell a property held for investment or business use (not your personal residence). The sale proceeds go to a qualified intermediary (QI) — not to you directly.

Identify a replacement property

You have 45 days from the sale date to identify potential replacement property or properties in writing.

Close on the new property

You must purchase (close on) one or more of the identified properties within 180 days of selling the original property.

Defer capital gains taxes

By reinvesting all sale proceeds into the new property, you defer paying capital gains and depreciation recapture taxes until you eventually sell the replacement property without doing another 1031 exchange.

In a 1031 exchange, boot refers to any value received by the investor that is not “like-kind” property — meaning, it’s cash or other non-qualifying property or value that you get as part of the exchange.

When you receive boot, that portion is taxable, even if the rest of the exchange qualifies for tax deferral.

How Boot Works in Practice:

Let’s say: You sell your old investment property for $600,000. You buy a new property for $550,000. You don’t reinvest the remaining $50,000. That $50,000 counts as boot and is taxed as capital gain, while the rest of the exchange ($550,000) remains tax-deferred.

How to Avoid Boot

Reinvest all proceeds from the sale into the replacement property. Match or exceed the value and debt of the relinquished property. Don’t receive cash from the qualified intermediary (QI) — let them handle the funds.

A Qualified Intermediary (QI) is essential in a 1031 exchange because IRS rules prohibit the investor from directly receiving the proceeds of the sale—doing so would disqualify the exchange and trigger capital gains taxes.

IRS Compliance and Tax Deferral

• Avoiding “constructive receipt”: If the investor has access to or control over the sale proceeds—even momentarily—it’s considered a taxable event. A QI acts as a neutral third party to hold the funds, ensuring the investor never “touches” the money.

• Maintaining eligibility: The QI facilitates the exchange in a way that aligns with IRS regulations under Section 1031, preserving the tax-deferred status of the transaction.

Coordinating the Exchange Process

• Document preparation: The QI drafts the necessary exchange agreements and assignment documents to properly structure the transaction.

• Timeline management: The QI helps the investor meet strict IRS deadlines—45 days to identify replacement property and 180 days to close on it.

Risk Mitigation and Professional Oversight

• Safeguarding funds: QIs typically hold the proceeds in a segregated, insured account, reducing the risk of misappropriation or loss.

• Expertise: They guide investors through the complex rules and help avoid costly mistakes that could invalidate the exchange.

In short, a QI isn’t just helpful—it’s legally required for a valid 1031 exchange. Without one, the transaction would likely fail to meet IRS standards, resulting in immediate taxation.

Yes, you can eventually move into a home purchased through a 1031 exchange, but only after meeting specific IRS requirements to demonstrate that the property was initially held for investment purposes.

Here’s how it works:

• Investment intent is key: The IRS requires that both the relinquished and replacement properties in a 1031 exchange be held for investment or business use. You cannot buy a property with the intent to immediately use it as your primary residence.

• Safe harbor period: While the IRS doesn’t specify an exact holding period, many tax professionals recommend renting the property out for at least two years and reporting rental income to clearly establish investment intent.

Transitioning to Personal Use

• After the holding period, you may convert the property to a primary residence. However, you must be cautious:

• Keep documentation showing the property was rented and treated as an investment.

• Avoid making personal-use improvements or moving in too soon, which could raise red flags with the IRS.

Tax Implications on Sale

• If you later sell the property after converting it to a primary residence, you may qualify for the Section 121 exclusion (up to $250,000/$500,000 of capital gains tax-free), but only if:

• You’ve owned the property for at least five years, and

• You’ve lived in it as your primary residence for at least two of the last five years.

Best Practices

• Consult a tax advisor before making the move to ensure compliance.

• Document everything—rental agreements, income, expenses, and your timeline for converting the property.