In brief
- 1
A $500,000 gain can carry $120,000-150,000+ in tax. That total stacks federal capital gains at 15-20%, the 3.8% Net Investment Income Tax, 25% depreciation recapture and the 5% Massachusetts tax. An exchange defers all of it.
- 2
The 45-day and 180-day deadlines do not move. You have exactly 45 calendar days from the sale to identify replacements in writing to your Qualified Intermediary, and 180 days to close. Miss by one day and the exchange is dead.
- 3
Name three properties, or keep a running total. The Three Property Rule allows up to 3 of any value. Under the 200% rule, a $1,000,000 sale caps the list at $2,000,000: four properties at $1,980,000 pass, and a fifth at $100,000 breaks it.
- 4
Cash left over or a smaller mortgage is taxable boot. Sell for $1,000,000 and buy for $950,000, and the $50,000 difference is taxable. Replace a $600K mortgage with a $400K one, and the $200K debt reduction is boot too.
- 5
A Qualified Intermediary has to hold the money. Take possession of it, even for a minute, and the exchange fails. QI fees usually run $750-1,500, and your attorney, CPA or agent cannot be your QI if they worked for you in the past two years.
Why I put every long-term investor onto a 1031
Section 1031 of the Internal Revenue Code is the best tax break a real estate investor gets. You sell an investment property, roll the proceeds into a new one, and defer the capital gains tax, potentially for as long as you keep exchanging.
How it works
When you sell an investment property at a gain, here is what you typically owe:
| Tax Type | Rate | Example ($500K Gain) |
|---|---|---|
| Federal Capital Gains | 15-20% | $75,000-100,000 |
| Net Investment Income Tax | 3.8% | $19,000 |
| Depreciation Recapture | 25% | Varies |
| State Tax (MA) | 5% | $25,000 |
| Total Potential Tax | $120,000-150,000+ |
A 1031 exchange lets you defer all of that by buying "like-kind" replacement property inside the deadlines.
What counts as like-kind
"Like-kind" is broader than most people think.
Qualifies:
- Any real property held for investment or business use
- Commercial to residential rental
- Land to improved property
- Industrial to retail
- Single property to multiple properties
Does NOT Qualify:
- Primary residence
- Property held primarily for resale (flips)
- Partnership interests
- Foreign real estate (for U.S. property exchanges)
The two deadlines that end the deal
The 1031 deadlines are hard. There is no wiggle room.
The 45-day identification period
From the day you sell, you have exactly 45 calendar days to identify replacement properties in writing to your Qualified Intermediary (QI).
Identification Rules:
| Rule | Description |
|---|---|
| Three Property Rule | Identify up to 3 properties regardless of value |
| 200% Rule | Identify any number if total value doesn't exceed 200% of relinquished property |
| 95% Rule | Identify any number if you acquire 95% of identified value |
Best Practice: I put almost everyone on the Three Property Rule. Name your first choice and two backups.
The 200% rule, worked through
The 200% rule is for the investor who wants more than three names on the list. You can identify as many replacement properties as you like, as long as their combined fair market value is no more than twice the price of the property you sold. Value is measured at the end of the 45-day window.
Say you sell a building for $1,000,000. Your ceiling is $2,000,000 across everything you identify:
| Identified property | Value |
|---|---|
| Retail strip | $450,000 |
| Flex building | $500,000 |
| Small industrial | $550,000 |
| Mixed-use | $480,000 |
| Total | $1,980,000 (under the $2,000,000 cap) |
Add a fifth property at $100,000 and the list is worth $2,080,000. That breaks the 200% rule, and the only rescue is the 95% rule: you would have to close on 95% of the value you identified, about $1,976,000 of the $2,080,000, which in practice means buying nearly everything on the list. Fail both and the IRS treats you as having identified nothing, except property you had already closed on inside the 45 days. Keep a running total as you add names, and stop under the cap.
The 180-day closing period
You have to close on the replacement property within 180 days of selling the relinquished one (or your tax return due date, including extensions, if that comes first).
WARNING: These deadlines do not move for anything. Not the market, not a financing snag, not a natural disaster. Miss by one day and the exchange is dead.
You need a Qualified Intermediary
You cannot touch the sale proceeds yourself. A Qualified Intermediary has to:
- Hold all exchange funds in a segregated account
- Prepare exchange documentation
- Coordinate with title companies
- Disburse funds at closing
Choosing a QI:
| Factor | What to Look For |
|---|---|
| Experience | 10+ years, thousands of transactions |
| Security | Segregated accounts, bonded, insured |
| Financials | Audited financial statements |
| References | CPA and attorney recommendations |
Cost: QI fees usually run $750-1,500 for a standard exchange.
CRITICAL: You cannot use your attorney, CPA, or real estate agent as your QI if they've done work for you in the past two years.
Boot: what kills the deferral
"Boot" is any value you receive that doesn't qualify for deferral. Here is where it shows up.
Cash boot
Cash at closing, even by accident, creates taxable gain.
Example: You sell for $1,000,000 and buy the replacement for $950,000. That $50,000 difference is taxable boot.
Mortgage boot
Dropping your debt level can trigger boot too.
Example:
- Relinquished property: $1M value, $600K mortgage
- Replacement property: $1M value, $400K mortgage
- Boot: $200K (debt reduction)
How to Avoid Mortgage Boot:
- Acquire replacement property with equal or greater debt
- Add cash to offset debt reduction
- Acquire additional properties to increase total debt
The variations you'll run into
Delayed exchange (the usual one)
Sell first, then buy the replacement. This is the standard structure I described above.
Reverse exchange
Buy the replacement first, then sell. More moving parts and more money ($5,000-15,000+).
Improvement exchange
Use exchange funds to improve the replacement property. Every improvement has to be finished inside the 180 days.
Partial exchange
Exchange some of the proceeds and take boot on the rest, which is taxable.
Where this pays off in Central Massachusetts
A 1031 does real work in a market like ours. A few ways I see it used:
Trading Up:
Sell a $500K duplex in Worcester → Exchange into a $1.5M strip center with additional equity
Portfolio Diversification:
Sell a single-tenant retail property → Exchange into three industrial buildings
Geographic Consolidation:
Sell out-of-state holdings → Exchange into Central MA for easier management
The mistakes that blow up exchanges
Mistake #1: Starting too late
Start planning 60-90 days before you list. Line up potential replacements early.
Mistake #2: Not reinvesting enough
You have to reinvest ALL net proceeds to defer ALL gain. Anything short of that creates boot.
Mistake #3: Touching the funds
Take possession of the money, even for a minute, and the exchange fails. Bring in a QI from day one.
Mistake #4: Related-party deals
Selling to or buying from related parties triggers special rules and can disqualify you.
Mistake #5: Not documenting intent
Keep the records that prove investment intent: business plans, rental income, marketing materials.
Is a 1031 the right move for you?
Good Candidates:
- Long-term holders with significant appreciation
- Investors seeking to trade up or diversify
- Those with high income in sale year
- Multi-generational wealth planners
Poor Candidates:
- Short-term holders (potential dealer status issues)
- Those needing cash proceeds
- Investors unable to identify suitable replacement
- Situations where timeline cannot be met
Lornell Real Estate regularly assists investors with 1031 exchanges, helping source replacement properties that meet identification and closing deadlines. Contact us to discuss your exchange strategy.
1031 exchange is a transaction under Section 1031 of the Internal Revenue Code allowing investors to defer capital gains taxes indefinitely by reinvesting proceeds from a sold investment property into a like-kind replacement property within strict timelines.
Sources: IRS, Internal Revenue Code.
Limitations: Cap rates, pricing, and transaction volume cited reflect market-level averages at the time of publication and may not apply to individual properties. Property values depend on asset-specific factors including condition, tenant credit quality, lease terms, location, and financing structure. Tax rules (including 1031 exchange provisions, capital gains rates, and depreciation schedules) change with legislation. This article does not constitute investment, tax, or legal advice. Consult a qualified CPA, attorney, and commercial real estate broker before making transaction decisions.
For owners
What would a sale leave you?
Put in a price. The commission and attorney start at the typical figures for a building at that price; change any line to your own.
Deed excise at $4.56 per $1,000; Cape Cod (Barnstable County) pays $6.48, so enter it as Elsewhere.
Enter a sale price to see your sheet.
