1031 exchanges and depreciation recapture: deadlines, boot, and exit planning

A like-kind exchange under §1031 lets you sell investment real estate and buy replacement real estate without recognizing gain. Since 2018 it has applied only to real property, but "like-kind" is defined broadly. Raw land exchanged for an apartment building qualifies, as does a rental house exchanged for a retail strip.

The deadlines are absolute

• 45 days from the sale to identify replacement property in writing.
• 180 days from the sale, or the due date of your return if earlier, to close.

Weekends and holidays do not extend these, though IRS postponements for federally declared disasters can. If your sale closes in late 2026, file an extension so the return due date does not cut the 180-day window short.

Use a qualified intermediary from the start

You can't receive or control the sale proceeds. A qualified intermediary holds the funds and must be engaged before the relinquished property closes. Your attorney, your agent, or anyone who has acted as your agent within two years can't serve. Help with earlier 1031 exchanges, or routine title and escrow services, doesn't count against them.

Key numbers: 45 days to identify · 180 days to close · identify up to three properties, or more under the 200% rule.

What creates taxable boot

You fully defer only if you buy property of equal or greater value and reinvest all net equity. Cash you keep, and debt that goes down without being replaced, are taxable boot. You can offset reduced debt by adding cash, but not the reverse.

Why recapture makes exchanges more valuable now

With 100% bonus depreciation and cost segregation, investors are claiming much larger deductions in the early years of ownership. On a taxable sale, that depreciation is recaptured. Section 1245 recapture on personal property components is ordinary income, bonus on 15-year land improvements is also ordinary income to the extent it exceeds straight-line depreciation, and unrecaptured §1250 gain on the building is taxed at up to 25%. An exchange defers the capital gain and the building's 25% gain, but cost-segregated components need planning. Furniture and other personal property don't qualify for §1031, so their share of the price is taxed as a sale. Recapture under §1245 on components that count as real estate is deferred only if the replacement property has enough §1245 property of its own (see the Form 8824 instructions, line 21). A cost segregation study on the replacement property therefore serves two purposes: it supports that match and captures any additional basis.

A worked example

An investor sells a $2.0M apartment building with an adjusted basis of $900,000, including $400,000 of prior depreciation, of which about $150,000 came from cost segregated components. A taxable sale triggers up to $150,000 of ordinary recapture, $250,000 of 25% gain, and $700,000 of capital gain, plus the 3.8% net investment income tax. Recapture on the components can't exceed the gain on them, which for written-off items is roughly the part of the price allocated to them, so the recapture is often less, with the difference taxed as capital gain. Exchanging into a $2.6M property defers the 25% gain and the capital gain. The ordinary recapture is deferred only if the replacement property has enough §1245 components of its own, and any price allocated to furniture is taxable either way.

In Connecticut

Because its income tax starts from federal AGI, Connecticut follows the federal deferral. The real estate conveyance tax is treated differently, because the statute's exemptions don't include like-kind exchanges. The seller therefore still pays that tax on the relinquished property when the deed is recorded, at 0.75% to 2.25% to the state, depending on property type and price, plus at least 0.25% to the town. See our Connecticut investor guide.

Basis step-up at death

Under current law, heirs receive a basis equal to fair market value at death. Investors who exchange repeatedly and hold until death can permanently avoid the deferred gain and recapture.

Common mistakes

1. Engaging the intermediary after closing.
2. Taking title to replacement property in a different taxpayer's name, such as a new LLC taxed as a partnership.
3. Overlooking reduced debt as a source of boot.
4. Exchanging property held primarily for sale, such as flips, which doesn't qualify.

How Summer Associates helps

Summer Associates' real estate team models exchange versus sale, coordinates with your intermediary, tracks identification deadlines, and reports the exchange on Form 8824.

This guide is general education based on federal and Connecticut law as of 2026-11-15. State rules differ and facts matter. Before acting, get advice for your situation from Summer Associates or another qualified advisor.