Do You Qualify for a 1031 Exchange? The Simple Rule to Know

If you’re a property owner, real estate investor or considering becoming one, you’ve probably heard about 1031 exchanges. A powerful tax-deferral strategy that allows you to sell investment property and reinvest the proceeds into another like-kind property, all while deferring capital gains and depreciation recapture taxes.

But here’s the catch, not all types of property (like, personal use) qualifies, and not every “investment” strategy can be paired with a 1031 exchange. If you’re wondering whether a 1031 exchange is right for you, keep reading and remember the key is to keep it simple.

The Basics! What Is a “Like-Kind” Exchange?

Under IRS Section 1031, a like-kind exchange allows you to defer paying taxes when you sell an investment or business-use property and reinvest the proceeds into another property of the same nature or character. The term “like-kind” is broader than it sounds, it doesn’t mean the properties must be of identical use. For example, you can exchange a rental condo for a commercial office building, or raw land for an apartment complex. As we’ll discuss later, as long as you hold the real estate for investment or business use, it qualifies as like-kind.

Keep it simple! Based on the “like-kind” definition, would you consider your sale and purchase property like-kind properties?

The #1 Qualification: Intent

To qualify for a 1031 exchange, you must hold both the property you’re selling and the one you’re buying for investment purposes or use in a trade or business. That means:

• Rental properties usually qualify.
• Commercial properties typically qualify.
• Raw land held for appreciation generally qualifies.
• Vacation homes might qualify if properly used as a rental/investment property per the tax code. 
• Second homes are typically personal use and therefore do not qualify.

Your primary residence likely doesn’t qualify either, since you use it for personal purposes, not investment. However, if you’re selling a property that includes both personal and investment components—like a home with a large parcel of land—the investment portion may still qualify. The same applies to homestead properties.

According to IRS Revenue Procedure guidelines, certain requirements must be met for a property (especially a vacation or second home) to qualify for a 1031 exchange. First, the property must be owned by the taxpayer for at least two years before the exchange. Second, during each of those two years, the property needs to be rented out for at least 14 days annually. Finally, the taxpayer’s personal use of the property must be limited to no more than 14 days per year—or 10% of the days it was rented, whichever is greater.

To clarify, outside of the revenue procedure pertaining to vacation and second homes as well as other provisions, there is no statue stating what that holding period must be. However, we have found that holding property for two tax cycles or more is recommended due to the pattern of previous rulings.

Keep it simple! Based on the key point of the 1031 exchange definition, held long-term for investment purposes or for use in a trade or business, do your properties qualify?

Developers, Flippers, and Dealers

If you’re in the business of buying, fixing and flipping homes or developing property for quick resale,1031 exchanges may not be for you. The IRS generally classifies these properties as inventory rather than investments, so it does not allow them to qualify for 1031 treatment.

Keep it Simple! Do you intend to resale shortly after acquiring? Remember, any property sold within a two year time span should be discussed with your CPA or Tax Advisor before selling it and entering it into a 1031 exchange. 

Why It Matters

Attempting to use a 1031 exchange on a non-qualifying property could invalidate the entire transaction, triggering taxes you thought you were deferring. That could derail your investment plans and create an unexpected tax bill.

How to Know for Sure

If you’re actively investing in real estate or thinking about selling an existing property to reinvest in another, it’s worth exploring whether a 1031 exchange could work for your situation. Every deal is different and the details matter. Keep it simple! What is the best next step? Talk to a qualified Tax Advisor or CPA who has extensive experience in real estate and 1031 exchanges. Plus be sure to loop in a 1031 exchange expert, or facilitator, like our team. Together, we can review your property, your intentions, and your timeline to help you stay compliant while maximizing your return.

The information presented is for information purposes and is not intended as investment, legal, tax or compliance advice. Land 1031 does not offer or sell investments or provide investment, legal, or tax advice.

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