In a previous article, I explained the tax implications of selling a real investment. If you’re a real estate investor looking todefer capital gains taxes when selling investment property, you’ve probablyheard of the 1031 exchange. Named after Section 1031 of the IRS Code, this powerful tool allows you to defer taxes by reinvesting the proceedsfrom a property sale into a "like-kind" replacement property.
But did you know there’s more than one way to do a 1031 exchange?
There are really three different types:
1. Straight (or Delayed) 1031 Exchange
The Basics:
This is the most common type of exchange. In a straight 1031 exchange, you sell your existing investment property and then use the proceeds to purchase a new one.
Timeline Rules:
- You have 45 days from the sale of your property to identify potential replacements.
- You must close on the replacement property within 180 days of the original sale.
Key Points:
- You can’t take possession of the sale proceeds — they must be held by a Qualified Intermediary (QI).
- The replacement property must be of equal or greater value to fully defer taxes.
- You can identify up to three properties, regardless of their market value, or use other identification rules.
When It Works Best:
When the market has ample inventory and you’re confident youcan find and close on a replacement quickly.
2. Reverse 1031 Exchange
The Basics:
In a reverse exchange, you buy the replacement property first, and then sell the relinquished property - essentially the oppositeof a straight exchange.
How It Works:
- The investor cannot technically own both properties at the same time, so the replacement property is "parked" with an Exchange Accommodation Titleholder (EAT) until the original property is sold.
Timeline Rules:
- You still have 45 days to identify the relinquished property and 180 days to complete the sale — same as a straight exchange, but in reverse order.
Key Points:
- More complex and expensive due to additional legal and holding structures.
- Requires strong financing or cash, since you’re buying before selling. There will be a period of time when you own both properties, so you’ll need the ability to afford both.
- Useful when you’ve found the perfect replacement but haven’t yet sold your current asset.
When It Works Best:
In a competitive market when you can’t risk losing the ideal replacement property while waiting to sell your current one.
3. Improvement (or Construction) 1031 Exchange
The Basics:
An improvement exchange allows you to use exchange proceeds to improve the replacement property - even if those improvements haven’t been completed at the time of the exchange.
How It Works:
- Like a reverse exchange, the replacement property is temporarily held by an EAT.
- You use the exchange funds to build or renovate the property while it’s parked.
- Improvements must be completed and titled to you within the 180-day window.
Key Points:
- Gives flexibility to add value to a property you wouldn’t otherwise exchange into.
- All construction and improvements must be completed before the exchange period ends.
- You can’t make improvements to a property you already own - it must be held by the intermediary during the work.
When It Works Best:
When you’re buying a fixer-upper or development site andwant to use the exchange funds to fund construction or renovations.
Final Thoughts
All three exchange types offer savvy investors a chance to defer capital gains taxes and build wealth more efficiently — but each has its own complexity and ideal use case:
Before pursuing any 1031 exchange, make sure to consult witha Qualified Intermediary, your CPA, and legal counsel. The IRS rules arestrict — but when done right, these strategies can be game-changers for your portfolio.
