Thousands of investors use Section 1031 every year to strategically defer capital gains taxes on the sale of investment real estate. But even with a straightforward concept, the IRS rules can create confusion. Here are the top misconceptions about 1031 exchanges:

1. Misconception: “Like-kind” means I must trade the same type of property.

Clarified:
The IRS views “like-kind” very broadly for real estate. Nearly all property held for business or investment qualifies, meaning you can swap very different types—like exchanging a rental home for commercial buildings, raw land, farmland, or even interests in a Delaware Statutory Trust (DST). It’s the investment purpose that matters, not the property category.

2. Misconception: I can use a 1031 Exchange on my personal vacation home or second home.

Clarified:
Personal-use properties generally do not qualify unless they meet strict rental and limited-use rules over at least two years. That said, with proper planning, you can convert a personal property into one that meets 1031 standards, or structure an exchange to acquire a future vacation home.

3. Misconception: I can get extra time on the 45-day identification period.

Clarified:
The 45-day identification deadline and the 180-day completion period are absolute. They include holidays and weekends and cannot be extended—except when the IRS issues relief due to a federal disaster declaration. Missing the deadlines will invalidate the exchange, so early preparation and backup options are critical.

4. Misconception: I must match the exact mortgage debt I had on the property I sold.

Clarified:
You don’t need to mirror the same loan amount. To fully defer taxes, the value and equity in the new property must be equal to or greater than what you sold. You can replace debt with cash, secure different financing, or use seller financing. Falling short on value or equity creates taxable “boot.”

5. Misconception: A Reverse Exchange gives me as much time as I need to sell my old property.

Clarified:
Reverse Exchanges follow the same rigid timeline as standard exchanges: 45 days to identify the relinquished property and 180 days to complete the sale. These deadlines cannot be adjusted, and missing them makes the exchange taxable. Reverse Exchanges offer flexibility in order of purchase/sale—but not in timing.

6. Misconception: I can swap properties with a family member and still defer taxes.

Clarified:
You can exchange with related parties, but these transactions are heavily scrutinized. If either party disposes of their property within two years, the entire exchange can be retroactively disallowed. Proper structuring and documentation are essential to avoid triggering immediate taxes.

7. Misconception: I can add a spouse or child to the title on my new property without any issues.

Clarified:
Under the “same taxpayer rule,” the same person or entity that sells must be the one that buys. Changing title—such as adding family members or transferring into an LLC—during the exchange can jeopardize the deferral. Exceptions exist, but those structures must be planned before starting the exchange.

8. Misconception: I can finance my buyer and still defer all my taxes.

Clarified:
Seller financing complicates 1031 Exchanges. If you receive loan payments or a note directly, the IRS may treat this as taxable income or “boot.” With careful structuring, you may still preserve tax deferral, but timing and how the note is handled are critical—and not always feasible within the 180-day window.

9. Misconception: After I buy the Replacement Property, I can use leftover exchange funds to renovate it.

Clarified:
Once you take title to the new property, the exchange is complete and you can no longer spend exchange proceeds on improvements. To use exchange funds for construction, you must use a Build-to-Suit or Improvement Exchange where a third party temporarily holds title until the upgrades are completed within the exchange deadlines.

10. Misconception: Taking cash out at closing kills the 1031 Exchange.

Clarified:
You can take some cash or other non-qualifying proceeds at closing, but that portion becomes taxable “boot.” The rest of the transaction may still qualify for tax deferral. Partial exchanges are common—just understand that whatever you pocket will be taxed.

11. Misconception: I can buy REIT or UPREIT shares to complete my 1031 Exchange.

Clarified:
Direct investments in REITs or UPREITs don’t qualify for 1031 treatment because they involve securities, not real property. However, DSTs do qualify and can serve as flexible, passive Replacement Properties. If your long-term plan is to end up in a REIT, a DST-to-UPREIT transition may work—but the second step is typically taxable unless carefully structured.

Need Help?

As we move toward the end of the year, 1031 Exchanges tend to become even more common, with investors looking to reposition assets, optimize tax planning, and close before December 31. While these strategies can offer substantial financial advantages, they also come with strict rules and timelines. As a real estate agent, I’m not able to provide tax or legal advice, but I can connect you with an excellent 1031 Exchange specialist who can guide you through the process with confidence and clarity. If you’re considering a tax-deferred exchange, now is the perfect time to explore your options.