1031 Exchange Explained: A Step‑by‑Step Guide for Commercial Investors

A 1031 exchange is one of the most effective tools for growing a commercial real estate portfolio while deferring capital gains and depreciation recapture taxes. The tradeoff is precision: strict timelines, documentation rules, and structuring details must be followed exactly. You don’t need to be a tax attorney to execute one, but you do need a disciplined process and the right team. Here’s how REACH Commercial Real Estate recommends navigating a 1031 exchange from sale to purchase.

What Is a 1031 Exchange?

A 1031 exchange (named after Section 1031 of the Internal Revenue Code) allows you to defer capital gains taxes by selling an investment property (the “relinquished” property) and acquiring another investment property (the “replacement”) of like‑kind. In commercial real estate, “like‑kind” is broad, and can include office to industrial, retail to multifamily, land to warehouse, as long as both are held for investment or productive use in a trade or business.

Key benefits:

• Tax deferral on capital gains and depreciation recapture

• Portfolio growth and consolidation/diversification

• Improved cash flow by trading into higher‑yield assets

  
  

Important limitations:

• Primary residences and flips do not qualify

• Strict deadlines and the use of a Qualified Intermediary (QI) are mandatory

• Cash or debt reduction received may be taxable (“boot”)

  
  

The 1031 Exchange Timeline at a Glance

• Day 0: Close on the sale of the relinquished property.

• Day 45: Deadline to identify replacement property (written, formal identification).

• Day 180: Deadline to close on the replacement property. These periods run concurrently; day 180 is not 45 + 180. Miss either deadline, and the exchange fails.

  
  

Step 1: Assemble Your Team Early

Before you list or sell, line up:

• Qualified Intermediary (QI): Holds the sale proceeds in escrow and facilitates all exchange documents. You cannot touch the funds.

• Commercial real estate advisor: Sources on‑market and off‑market replacement options, underwrites returns, and coordinates due diligence.

• CPA/Tax advisor: Confirms eligibility, basis, potential boot, and depreciation strategy.

• Real estate attorney: Reviews contracts, title, and entity structures.

• Lender/mortgage broker: Pre-qualifies financing to meet debt‑replacement requirements.

  
  

Tip: Vet your QI’s financial controls and bonding. Not all QIs are equally secure.

Step 2: Know the Non‑Negotiable Deadlines

Two clocks start the day you close the sale of your relinquished property. You have 45 days to identify replacement property in writing and 180 days to close on one or more identified properties. These run concurrently, not consecutively. Missing either deadline disqualifies the exchange. Practically, that means you should be shopping, underwriting, and lining up financing before your sale closes.

Step 3: Sell the Relinquished Property the Right Way

Your purchase and sale agreement should include 1031 cooperation language, and at closing, the proceeds must go directly to the QI, not to you or any account you control. You’ll execute an exchange agreement with the QI at or before closing. This isn’t just paperwork; it preserves tax deferral by preventing constructive receipt of funds.

Step 4: Match Value and Debt to Avoid Boot

To fully defer taxes, you need to reinvest all net proceeds, purchase a replacement property of equal or greater total value, and replace equal or greater debt. If you reduce debt on the new acquisition, you can offset that reduction by adding cash. Any cash you take out at closing or any shortfall in debt replacement may create a taxable “boot,” so plan your capital stack with your lender and CPA before you go under contract.

Step 5: Execute Due Diligence and Financing

Due diligence runs on a tight clock within the 180-day window, so front-load what you can. Financial review should cover rent rolls, trailing twelve-month operating statements, all leases and amendments, estoppels, and CAM reconciliations. 

On the physical side, order a property condition assessment, roof and HVAC evaluations, an environmental Phase I (and Phase II if flagged), an ALTA survey, and confirm zoning compliance. 

Your legal team should clear title, review easements, CC&Rs, and SNDAs. In parallel, lock financing terms early and confirm the lender’s underwriting, appraisal, and legal timelines fit comfortably inside your exchange deadlines. Weekly coordination with your lender, QI, and closing attorney keeps documents synchronized and surprises to a minimum.

Step 6: Close the Replacement Property by Day 180

At closing, the QI wires exchange proceeds directly to the settlement agent; you should never receive or control the funds. The title must vest in the same taxpayer that sold the relinquished property (or in a compliant structure such as a DST or TIC when appropriate). Verify that the closing statement accurately reflects the exchange so you don’t inadvertently create a boot. After closing, provide final settlement statements to your CPA so they can file IRS Form 8824 and document basis carryover and any recognized boot.

Popular Variations to Know

• Reverse Exchange: Acquire the replacement property before selling the relinquished one. More complex and costlier, but useful in tight markets.

• Improvement (Build‑to‑Suit) Exchange: Use exchange funds to make capital improvements on the replacement property within the 180‑day period.

• Delaware Statutory Trust (DST): A passive replacement option for owners seeking mailbox‑money yields and professional management.

These structures carry additional rules and fees; engage experienced counsel early.

Common Pitfalls (and How to Avoid Them)

• Waiting too long to identify: Shop early; pre‑negotiate LOIs to shorten escrow.

• Touching the money: Always route proceeds through the QI.

• Title/entity mismatch: Maintain continuity of the taxpayer between sale and purchase.

• Underestimating timelines: Factor in lender underwriting, appraisals, third‑party reports, and municipal approvals.

• Ignoring debt replacement: Plan capital stack with your advisor to avoid taxable boot.

  
  

How REACH Commercial Real Estate Helps

A successful 1031 is part tax strategy, part deal execution.

REACH CRE helps you:

• Underwrite hold/sell scenarios and confirm 1031 viability with your CPA.

• Source and screen replacement properties aligned to your cash flow and risk goals.

• Coordinate timelines with QIs, lenders, and attorneys to protect compliance.

• Negotiate terms, manage due diligence, and keep the deal on schedule.

Thinking about a 1031 exchange? Let’s map your objectives and build a timeline so you hit every milestone without surprises.

Contact REACH.

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