The taxes a 1031 defers
When you sell an investment property at a profit, several taxes normally come due: federal capital gains tax, depreciation recapture taxed at up to 25%, the 3.8% net investment income tax for higher earners, and state capital gains tax. Together these can consume 20–35% of your gain. A properly structured 1031 exchange defers all of them, letting the full amount roll into your next property and compound.
Deferral is not forgiveness. The deferred gain carries forward into the replacement property's cost basis, so it resurfaces if you later sell without exchanging again. Many investors chain exchanges across decades and ultimately pass property to heirs, whose stepped-up basis can eliminate the deferred gain entirely — the reason 1031 exchanges are central to long-term real estate wealth planning.
The rules that make or break the exchange
The timeline is unforgiving. From the day you sell, you have 45 calendar days to formally identify replacement properties and 180 days to close on them, with no extensions for weekends or holidays. Missing either deadline disqualifies the entire exchange and triggers the full tax bill.
To defer all tax, you must reinvest all of your net proceeds and acquire property of equal or greater value, replacing any debt that was paid off. Any cash you take out — known as "boot" — is taxable. You also cannot touch the sale proceeds; a qualified intermediary must hold the funds throughout. Given the stakes and complexity, always run an exchange with an experienced intermediary and tax advisor.