1031 Exchange for Rental Property and Other Investment Real Estate

By Skyline Capital Investments · Updated October 26, 2026 · 9 min read

How a 1031 exchange works for rental property

A 1031 exchange for rental property works by selling the rental through a qualified intermediary and using all of the proceeds to buy other real estate held for investment or business use within strict deadlines. Done right, you pay no federal tax on the gain in the year of sale. The gain carries over into the new property and is taxed later, when you sell without exchanging again.

Section 1031 of the Internal Revenue Code has applied only to real property since 2018. The IRS states it plainly on its real estate tax tips page: “Section 1031 now applies only to exchanges of real property.” A rental house, a duplex, an apartment building, a strip center and a parcel of land held for investment all count.

The usual sequence for a rental owner is short. You sign an exchange agreement before the sale closes, the qualified intermediary receives the proceeds, you identify replacement property in writing within 45 days, and you close on it within 180 days or by your tax return due date, whichever is earlier (Treas. Reg. 1.1031(k)-1(b)). Our 1031 exchange rules guide covers the identification limits in detail.

What counts as 1031 investment property

1031 investment property is U.S. real property you hold for investment or for productive use in a trade or business. The final regulations at Treas. Reg. 1.1031(a)-3, in force for exchanges starting after December 2, 2020, define real property as land, buildings, other inherently permanent structures and their structural components. Apartment buildings are named in the regulation as an example.

What does not count matters just as much. A home you live in, property you hold mainly to resell (dealer or flip property) and interests in a partnership or LLC are all outside Section 1031. Real property in the United States is also not like-kind to real property abroad.

Is a 1031 exchange only for investment property?

No. A 1031 exchange is for real property held for investment or used in a trade or business, so a building you operate from also qualifies. A dentist who owns her office building, a contractor with a shop and yard, and a landlord with ten rentals can all exchange. What they have in common is that none of the property is a personal residence or inventory held for sale.

You can also mix the two. Business-use property can be exchanged for investment property and the reverse. The test applies to how you hold each property, not to what kind of building it is.

How long to hold a rental before a 1031 exchange

Section 1031 sets no minimum holding period for most rentals. The question is your intent: you have to hold both the old and new property for investment or business use, and a rental bought and sold within a few months can look like property held for resale. Many advisors use two years as a comfort level, but that figure comes from practice and from the two specific rules below, not from the statute.

Exchanging a vacation home or second-home rental

A vacation home or second home can qualify if it meets the Rev. Proc. 2008-16 safe harbor. For each of the two 12-month periods before the exchange, and each of the two after it, you must rent the unit at a fair rent for at least 14 days, and your personal use cannot exceed the greater of 14 days or 10% of the days it was rented at fair rent.

A cabin you use every summer and rent for one week will not meet that test. If the replacement property later fails it, the procedure tells you to file an amended return and treat the sale as taxable. Our guide to the 1031 exchange and your primary residence covers homes in more depth.

1031 exchange for commercial property and other property types

You can 1031 exchange a rental into commercial property, or commercial real estate into rentals, because U.S. real property is generally like-kind to other U.S. real property. The IRS says real properties are generally of like kind “regardless of whether they’re improved or unimproved.” A fourplex can become a retail building, a warehouse or land.

The tax result is the same, but the depreciation schedule may change. Residential rental buildings are depreciated over 27.5 years (IRS Publication 527), and nonresidential buildings over 39 years (IRS Publication 946). Moving from apartments into an office building generally means slower deductions on any new basis you add. Ask your CPA to run both before you choose.

Owners also exchange in the other direction for practical reasons: one large apartment building can be easier to manage than eight scattered houses, and a triple net building can suit an owner who wants fewer tenant calls. You can exchange one property for several, or several for one, as long as the value, equity and debt tests below are met overall.

Equal or greater value: reinvest the equity, replace the debt

To defer all of the gain, buy replacement property worth at least your net sale price, reinvest all of the cash the intermediary holds and take on equal or greater debt, or add cash to make up any shortfall. Fall short on any of these and part of the gain becomes taxable.

Money or other property you receive is called boot. The IRS says that if you receive other property or money, “you must recognize a gain to the extent of the other property and money received.” There are two common kinds:

• Cash boot: cash you keep at closing, or exchange funds you take back from the intermediary.
• Mortgage boot: debt paid off on the old rental that is not replaced with new debt or added cash on the new one.
• Rent prorations, security deposit credits and loan fees on the closing statements can also create small amounts of taxable boot. Have your CPA review both settlement statements.
• Losses are never recognized in a like-kind exchange, so a rental that dropped in value is often better sold outright.

What happens to depreciation after a rental property exchange

Depreciation recapture is deferred, not erased, in a 1031 exchange. The depreciation you took on the old rental lowers the basis of the new property, so the deferred recapture and capital gain are still there when you finally sell in a taxable sale.

Under Treas. Reg. 1.168(i)-6, the carried-over basis generally keeps depreciating over the old property’s remaining recovery period, and any extra basis from new money or new debt starts its own fresh schedule. Your CPA can also elect to treat the whole basis as newly placed in service.

The 2025 tax law (P.L. 119-21) made 100% bonus depreciation permanent for qualifying property acquired after January 19, 2025, and IRS Notice 2026-11 gives the interim rules. A cost segregation study on the replacement building can move part of the basis into shorter lives, but how bonus applies to carried-over basis versus new basis in an exchange is technical. Settle that with your CPA before you file.

Under current law, heirs who inherit property generally take a basis equal to its fair market value at death (IRC Sec. 1014), which is why some owners exchange for decades and never sell.

Worked example: exchanging a 12-unit rental

You own a 12-unit building and accept an offer of $1,800,000. You paid $1,000,000 and have taken $280,000 of depreciation, so your adjusted basis is $720,000. Selling costs are $108,000 and you owe $600,000 on the loan. Your gain is $972,000 and your net equity, which goes to the qualified intermediary, is $1,092,000.

If you sold without an exchange and were in the top 2026 bracket, federal tax would be about $70,000 on the depreciation at 25% (IRS Topic 409), $138,400 on the remaining $692,000 at 20% (Rev. Proc. 2025-32 thresholds) and $36,936 of net investment income tax at 3.8% (IRS Topic 559). That is $245,336, before any state tax.

• Full exchange: the replacement costs more than the $1,692,000 net sale price, all $1,092,000 of equity is reinvested and the new loan is larger than the old one, so the whole $972,000 is deferred.
• Partial exchange: the $150,000 you keep is taxable. At top federal rates that is roughly $35,700 (20% plus 3.8%) to $43,200 (25% plus 3.8%), depending on how much is treated as depreciation-related gain.
• Replacement basis equals the price minus the deferred gain: $2,400,000 minus $972,000, or $1,900,000 minus $822,000.

Mistakes that break a rental property exchange

Most failed rental exchanges fail on process, not on the property. The tax code is strict about who touches the money and when, and a few errors cannot be fixed after closing.

• Taking the proceeds: if the sale money is wired to you, even for a day, the exchange is generally over. Line up the intermediary before the closing date.
• Missing day 45: an identification sent late, or not signed and delivered to the intermediary, leaves you with nothing to buy inside the exchange.
• Forgetting the return due date: a rental sold in November or December can lose weeks of its 180 days unless you extend your return.
• Changing title: the same taxpayer that sold should buy. If you sold as an individual, buying through a new partnership with a partner can cause problems.
• Buying from a relative: related-party purchases get extra scrutiny under Section 1031(f) and are often not allowed when you are the one acquiring.
• Trading down without a plan: buying a cheaper building or taking a smaller loan creates boot, so set your target price and debt before you list.

Steps for a 1031 exchange on a rental property

The steps for a rental property exchange are the same as any 1031, with a few landlord-specific details around tenants, leases and deposits. Start before you list.

• Talk to your CPA about the tax at stake and whether an exchange, an outright sale or a mix fits your plans.
• Choose a qualified intermediary and sign the exchange agreement before your sale closes.
• List or market the rental, and add exchange cooperation language to the purchase contract.
• Transfer leases, security deposits and service contracts to the buyer at closing; keep the deposit and proration credits visible on the closing statement for your CPA.
• Identify replacement properties in writing by day 45.
• Close on the replacement by day 180 or your return due date, filing an extension if the sale was late in the year.
• Report the exchange on Form 8824 with your return for the year of the sale.

State rules: California and other clawback states

States generally follow the federal deferral, but some keep track of gain when you exchange out of state. California requires Form FTB 3840 from anyone who exchanges California property for property outside California, for the year of the exchange and every year after until the deferred California gain is recognized. The rule applies to exchanges in tax years beginning on or after January 1, 2014.

Boot is also taxed at the state level in states with an income tax. If you sell a rental in one state and buy in another, ask your CPA how both states will treat the deferred gain.

Selling your rental or apartment building to Skyline

Skyline Capital Investments buys apartment buildings with five or more units nationwide. We buy directly, close on your timeline, and can work inside 1031 deadlines. If you have a replacement in view, we can set the closing date around it and cooperate with your qualified intermediary on the assignment and wiring.

Before you call, you can estimate the tax you would defer with the 1031 exchange calculator and the recapture piece with the depreciation recapture calculator.