1031 Exchange Explained: How the Process Works Step-by-Step

If you read Part 1 of our 1031 Exchange series, you already know how a 1031 can help defer capital gains taxes when selling investment property. But how does it actually work?

In this post, we’ll break down the entire 1031 Exchange process — including timelines, required parties, and what to expect — so you can move forward with clarity and confidence.

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🔢 Step-by-Step Guide to a 1031 Exchange:

✅ Step 1: Sell Your Existing Investment Property

Your current property (called the “relinquished property”) must be sold first. The proceeds from this sale cannot go directly to you — they must go to a Qualified Intermediary (QI).

⚠️ Tip: Never take possession of the sale funds, or you risk disqualifying the exchange.

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✅ Step 2: Engage a Qualified Intermediary (QI)

The QI is a neutral third party who:

• Holds the proceeds from the sale
• Prepares legal documents
• Facilitates the eventual purchase of your replacement property

You must select a QI before the sale closes.

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✅ Step 3: Identify Your Replacement Property

From the date your relinquished property closes, you have 45 calendar days to formally identify potential replacement properties — in writing — to your QI.

You can identify:

• Up to 3 properties (regardless of price), or
• More than 3, as long as their combined value doesn’t exceed 200% of the relinquished property’s sale price

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✅ Step 4: Acquire Your Replacement Property

You must close on the replacement property within 180 days of your relinquished property’s closing — or by the due date of your tax return, whichever comes first.

The new property must:

• Be of equal or greater value
• Be titled the same way as the relinquished property
• Be held for investment or business use

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✅ Step 5: File the Proper IRS Forms

You’ll need to file Form 8824 with your tax return to report the exchange. Your CPA or tax professional can help you ensure all documentation is accurate and compliant.

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💡 Common Pitfalls to Avoid

• Missing deadlines (45-day and 180-day windows are strict)
• Improper identification of replacement properties
• Failing to use a QI
• Buying a property of lesser value, which could trigger partial taxes (a “boot”)

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✅ Wrap-Up:

A successful 1031 Exchange can be a powerful way to grow your portfolio while deferring taxes — but timing and structure are everything. In Part 3, we’ll look at real-world 1031 scenarios and how savvy investors use them to their advantage, including 1031s into multi-family properties, vacation rentals, and even Delaware Statutory Trusts (DSTs).

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📌 Stay tuned for Part 3 tomorrow!