Demystifying 1031 Exchanges: Key Terms Every Investor Should Know

The term “like-kind” often confuses new investors. It doesn’t mean identical properties—it simply refers to real estate held for investment or business purposes. For example, an investor can exchange a rental home for an office building or a piece of raw land for a multifamily complex, as long as both properties are held for investment.

A Qualified Intermediary is a third party who facilitates the exchange. They hold the proceeds from the sale of the relinquished property and use them to acquire the replacement property on your behalf. Importantly, you can’t take direct control of the funds - doing so could disqualify the exchange.

The IRS imposes two important deadlines:

• 45-Day Rule: You must identify potential replacement properties within 45 days of selling your original property.
• 180-Day Rule: You must close on the new property within 180 days of the original sale.

These windows are strict, and missing them can invalidate your exchange. Planning ahead and working with professionals is essential.

In a delayed exchange, which is most common, the original property is sold first, and the replacement is purchased later. In a reverse exchange, the new property is purchased before the original one is sold. Reverse exchanges are more complex and often require more advanced planning.

DSTs are legal entities that allow multiple investors to hold fractional interests in institutional-grade real estate. These can qualify as replacement property in a 1031 exchange, offering a passive investment option for those seeking income without the responsibility of property management.

Also known as an UPREIT, a 721 exchange allows an investor to contribute property to a Real Estate Investment Trust (REIT) in exchange for operating partnership units, which can later be converted into shares of the REIT. While this strategy ends 1031 deferral, it offers liquidity and diversification.

"Boot" refers to any value received in a 1031 exchange that is taxable. This includes cash you receive, reduction in mortgage debt, or other financial benefits outside the direct property exchange. For example, if your replacement property has a smaller mortgage than your relinquished property, the difference is considered boot and becomes taxable. Structuring your transaction carefully helps minimize boot and avoid unexpected tax consequences.