1031 Exchange Explained: How Smart Investors Defer Taxes and Build Wealth

Selling an investment property can come with a big tax bill — but it doesn’t have to. A 1031 Exchange, named after Section 1031 of the IRS tax code, allows you to defer capital gains taxes by reinvesting the proceeds from the sale of one investment property into another “like-kind” property.

Instead of sending a large check to the IRS, you keep your equity working for you — compounding and growing over time.

How a 1031 Exchange Works

Here’s the simple version: When you sell an investment property, a qualified intermediary (QI) holds your sale proceeds while you identify and purchase your replacement property.

• You have 45 days to identify potential properties.
• You have 180 days to close on one (or more) of them.

If done correctly, the capital gains taxes from your sale are deferred — meaning your money continues to grow through reinvestment.

Why Investors Use It

A 1031 exchange can be a powerful wealth-building tool for experienced investors.

Top benefits include:

• Deferring capital gains taxes – More funds available for reinvestment.
• Portfolio growth – Trade up from one property to several, or move into higher-value assets.
• Geographic or asset diversification – Move your investment to stronger markets or different property types.
• Estate planning advantages – If the property is held until death, your heirs can receive a stepped-up basis, effectively eliminating the deferred taxes.

Example Scenario

An investor sells a rental property for $600,000 that was originally purchased for $300,000. Without a 1031 exchange, capital gains taxes could exceed $90,000–$120,000, depending on the state and tax bracket.

By executing a 1031 exchange, the investor reinvests the full $600,000 into a new property — leveraging that extra $90,000+ for additional appreciation, rent growth, or diversification.

Potential Drawbacks and Limitations

A 1031 exchange isn’t for everyone. Before starting, understand the rules and potential downsides:

• Strict deadlines — 45 days to identify, 180 to close. Miss either, and your exchange fails.
• No cash access — Funds must stay with the intermediary.
• Like-kind requirement — The new property must be used for investment or business, not personal use.
• Deferred, not erased — Taxes are postponed, not eliminated, unless you continue exchanging or pass the property to heirs.

Choosing the Right Qualified Intermediary (QI)

Because the IRS doesn’t regulate intermediaries, choosing the right QI is one of the most important decisions you’ll make.

This is the company (or individual) that will hold your sale proceeds and oversee the exchange process.

Key questions to ask before choosing a QI:

• Where are my funds held? Look for segregated, FDIC-insured escrow accounts—not pooled ones.
• Are you bonded and insured? Confirm they carry a fidelity bond and E&O (Errors and Omissions) coverage.
• How long have you been in business? Longevity and experience matter.
• Do you provide written instructions and clear timelines? Transparency builds trust.
• Are you affiliated with a national title company or financial institution? That adds extra oversight and protection.

Remember: your real estate agent, attorney, CPA, or lender cannot serve as your intermediary — the IRS considers them “disqualified parties.”

Costs of a 1031 Exchange

The cost of a 1031 exchange is surprisingly reasonable compared to the potential tax savings. Fees vary by provider, property type, and complexity, but here’s a general overview:

• Basic Exchange Fee: Typically, $750–$1,500 for a straightforward single-property exchange.
• Reverse or Improvement Exchange: More complex structures can range from $3,000–$7,500+.
• Qualified Escrow Account Setup: Some QIs charge a small fee for account management or interest tracking.
• Additional Property Fees: Expect a small add-on (often $250–$500) for each extra property identified or closed.

When you compare these costs to the tens (or hundreds) of thousands in deferred capital gains taxes, the math speaks for itself — the savings usually outweigh the expenses many times over.

The Bottom Line

A 1031 exchange isn’t just about avoiding taxes — it’s about keeping your wealth in motion. It allows investors to grow, diversify, and strategically manage their real estate portfolios without losing momentum to taxes.

But it requires planning, precision, and a coordinated effort between your real estate agent, tax advisor, and lender. Getting your financing lined up early is critical — because missing the timeline by even a day can invalidate the exchange.

Thinking about selling an investment property and reinvesting through a 1031 exchange? Let’s talk about how to align your loan structure and timeline to make the process seamless. Feel free to reach out to me at 312-296-4175 or email me at connect@borislending.com. I’m here to help you navigate the process and answer your questions. I lend in all 50 states and I am never too busy for your referrals!!