1031 Like-Kind Exchange Guide

Why a QI is required

The IRS treats any moment you have control over the sale proceeds as "constructive receipt" — meaning you sold the property and bought another, which is a fully taxable transaction. The Qualified Intermediary's only job is to receive the proceeds at closing, hold them in escrow, and forward them directly to the closing of the replacement property — so you never legally or practically touch the cash.

The QI also prepares the exchange documents, executes the assignments of contract rights, and creates the paper trail the IRS requires under the safe-harbor regulations.

Who can and can't be your QI

Federal regulations specifically disqualify the following from acting as your QI:

Yourself or anyone you control. A family member. Your attorney, real estate agent, accountant, or other professional who has provided you services in the past 2 years (with narrow exceptions for routine financial services). The QI must be an independent third party whose only role in your transaction is facilitating the exchange.

The unregulated-industry problem

The QI industry has no federal license, no bonding requirement under federal law, and minimal oversight in most states. There have been multiple high-profile failures over the years where QIs went bankrupt or commingled client funds, leaving exchangers without their proceeds and without a completed exchange.

When choosing a QI, look for: fidelity bond and errors-and-omissions insurance with substantial coverage limits; segregated, qualified escrow accounts (not commingled with the QI's operating funds or other clients); dual-signature wire requirements; a track record of at least 5–10 years; and ideally membership in the Federation of Exchange Accommodators (FEA).

What boot is

Boot is any value you receive in the exchange that isn't like-kind replacement property. Boot is taxable in the year of the exchange — the rest of the gain is still deferred, but the boot portion isn't.

The two common forms:

Cash boot — any leftover proceeds the QI returns to you because you bought a less-expensive replacement. If you sell for $500,000 and buy for $450,000, the $50,000 difference is cash boot, taxable as gain.

Mortgage boot (debt relief) — if your new mortgage is smaller than your old mortgage, the IRS treats the difference as if you received cash. If you paid off a $300,000 mortgage on sale and only took on a $250,000 mortgage on the replacement, that's $50,000 in mortgage boot.

To avoid boot: buy equal or up in value, and replace equal or more debt (or add cash to make up the difference). This is sometimes called the "equal-or-up" rule.

Can I do a 1031 exchange on a primary residence?

No. 1031 exchanges only apply to property held for productive use in a trade or business, or for investment. Your primary residence doesn't qualify. However, primary residences have their own tax break: Section 121 excludes up to $250,000 of gain ($500,000 married filing jointly) if you've lived in the home for at least 2 of the last 5 years. The two breaks can sometimes be combined when a former rental becomes a primary residence (or vice versa), but the timing and proration rules are intricate — talk to a tax pro.

How much does a 1031 exchange cost?

The QI fee is the main direct cost — typically $800–$1,500 for a standard delayed exchange, more for reverse or improvement structures ($3,500–$7,500+). Beyond that, you pay normal closing costs on both transactions (title, escrow, transfer tax, lender fees) and any additional legal or tax-advisor fees. Compared to the tax you defer — often tens or hundreds of thousands of dollars — the QI fee is small.

What happens to my cost basis?

Your cost basis carries over from the relinquished property into the replacement, with adjustments for any additional cash you put in, debt changes, and boot received. This means your replacement property has an artificially low basis — you'll pay more in depreciation recapture and capital gains when you eventually sell without exchanging. Many investors keep exchanging for decades and then hold until death, when heirs receive a stepped-up basis and the deferred gain is permanently eliminated.

Do states recognize 1031 exchanges?

Most states follow federal 1031 treatment, but a handful have clawback rules: California, Oregon, Massachusetts, and Montana require ongoing reporting and may eventually tax the deferred gain if you later sell the replacement without exchanging again. Pennsylvania historically didn't recognize 1031 at the state level for individuals (though this changed for tax years 2023 and later). If you're moving across state lines as part of the exchange, the state tax angle is worth special attention — ask your CPA.

Can I exchange a property I own with a partner?

Real estate held in a partnership or multi-member LLC raises complications, because the partnership owns the property, not the individual partners. A 1031 exchange must be done at the entity level — all partners participate, or none do. "Drop and swap" strategies, where the partnership distributes property to individual partners before the sale so each can do their own 1031, are common but face IRS scrutiny over the holding period and intent. This is one of the trickiest areas of 1031 practice and genuinely requires a tax attorney.

What if my replacement property falls through after I've identified it?

If you used the 3-property rule and identified backups, you can close on a different identified property within the 180 days. If you only identified one and it falls through, the exchange fails — the QI returns your funds and you pay capital gains tax on the sale. Always identify backup options within your chosen rule, even if your primary deal looks solid. Smart practice: identify up to 3 properties, with the primary plus 2 backups under contract or pre-negotiated.