1031 Exchange Glossary
Definitions for the key terms and concepts you will encounter when researching or completing a 1031 exchange.
B
Boot
Any non-like-kind property received in a 1031 exchange, including cash, debt relief, or personal property. Boot is taxable in the year of the exchange. Common sources of boot include mortgage relief (when the replacement property has less debt than the relinquished property) and cash taken out of the exchange proceeds.
Basis
The original cost of a property, adjusted for improvements, depreciation, and other factors. In a 1031 exchange, the tax basis of the relinquished property carries over to the replacement property, reduced by any boot received and increased by any boot paid. This carryover basis is how the IRS tracks the deferred gain.
D
Delaware Statutory Trust (DST)
A legal entity created under Delaware law that holds title to real estate and allows multiple investors to own fractional interests in institutional-quality properties. DSTs qualify as like-kind replacement property for 1031 exchanges under IRS Revenue Ruling 2004-86. They provide a passive investment option with professional management.
Depreciation Recapture
When investment property is sold, previously claimed depreciation deductions are "recaptured" and taxed at a rate of up to 25%. In a 1031 exchange, depreciation recapture tax is deferred along with capital gains tax. This can represent a significant portion of the total tax savings, especially for properties held for many years.
E
Exchange Period
The 180-calendar-day window following the sale of the relinquished property during which the investor must close on one or more replacement properties to complete the 1031 exchange. This deadline cannot be extended.
I
Identification Period
The 45-calendar-day window following the sale of the relinquished property during which the investor must formally identify potential replacement properties in writing. The identification must be submitted to the Qualified Intermediary and must comply with the Three-Property Rule or the 200% Rule.
Improvement Exchange
A type of 1031 exchange where exchange funds are used to make improvements or construct new buildings on the replacement property before the exchange is completed. This is accomplished using an Exchange Accommodation Titleholder (EAT) who holds title during the construction period.
L
Like-Kind Property
Real property held for investment or business purposes that qualifies for exchange under IRC Section 1031. The term is broadly interpreted — virtually any type of real estate can be exchanged for any other type of real estate (e.g., an apartment building can be exchanged for vacant land or a commercial office building).
N
Net Investment Income Tax (NIIT)
An additional 3.8% federal tax on net investment income, including capital gains from real estate sales, for individuals with modified adjusted gross income above $200,000 ($250,000 for married couples filing jointly). This tax is deferred along with capital gains in a 1031 exchange.
Q
Qualified Intermediary (QI)
A third-party facilitator required in a 1031 exchange who holds the exchange funds between the sale of the relinquished property and the purchase of the replacement property. The QI ensures the investor never has actual or constructive receipt of the funds, which would disqualify the exchange. Also known as an accommodator or exchange facilitator.
R
Relinquished Property
The investment or business property that is sold (given up) in a 1031 exchange. The relinquished property must have been held for productive use in a trade, business, or for investment purposes. The sale of this property starts the 45-day identification and 180-day exchange period clocks.
Replacement Property
The like-kind property acquired to complete the 1031 exchange. The replacement property must be identified within 45 days and acquired within 180 days of selling the relinquished property. To fully defer all taxes, the replacement property must be of equal or greater value and equity compared to the relinquished property.
Reverse Exchange
A 1031 exchange structure where the replacement property is acquired before the relinquished property is sold. This is accomplished using an Exchange Accommodation Titleholder (EAT) who takes title to the new property while the investor arranges the sale of the existing property. Must be completed within 180 days.
S
Stepped-Up Basis
When an investor who has deferred capital gains through 1031 exchanges passes away, the heirs receive the property at its current fair market value (stepped-up basis) rather than the investor's carryover basis. This effectively eliminates the deferred tax liability, making 1031 exchanges a powerful estate planning tool.
T
Three-Property Rule
An IRS rule allowing the exchanger to identify up to three potential replacement properties during the 45-day identification period, regardless of their total value. This is the most commonly used identification rule in 1031 exchanges.
200% Rule
An alternative IRS identification rule that allows the exchanger to identify any number of replacement properties, as long as their combined fair market value does not exceed 200% of the value of the relinquished property sold.