The 1031 Exchange Rules Every Net Lease Broker Should Know in 2026

TL;DR

Section 1031 of the Internal Revenue Code lets investors defer federal capital gains tax when they exchange real property held for productive use in a trade or business or for investment for other like-kind real property. The Tax Cuts and Jobs Act of 2017 narrowed the statute to real property only — personal property no longer qualifies. The mechanics have not changed since the 1990s: 45 days to identify replacement property, 180 days to close, a qualified intermediary handles the proceeds so the seller never receives them, and any non-like-kind value received ("boot") is taxed in the year of the exchange. State tax treatment is inconsistent — California clawbacks, Pennsylvania nonconformity, and several others trip up cross-state exchanges. This post covers what the rule requires, the three identification safe harbors, related-party traps, and the structures (reverse exchange, DST, tenancy-in-common) that institutional net lease investors actually use.

What 1031 Actually Is

Section 1031 of the Internal Revenue Code (26 U.S.C. § 1031) is one of the oldest provisions in the federal tax code — it has existed in some form since 1921. The core premise is straightforward: when a taxpayer exchanges one piece of investment real property for another, the IRS treats the transaction as a continuation of the original investment rather than a taxable sale, allowing the capital gain to be deferred (not eliminated) until the replacement property is ultimately sold in a taxable transaction.

A few points worth being explicit about:

• 1031 defers tax; it does not eliminate it. The capital gain is rolled into the replacement property's basis. When the replacement is eventually sold in a taxable transaction, the accumulated deferred gain becomes taxable (unless it's rolled again through another 1031, or the owner dies and basis steps up).
• 1031 is a voluntary structure. A taxpayer must proactively structure the sale and purchase to qualify. Selling one property and then buying another without the intermediary and timing mechanics gets you no 1031 treatment.
• 1031 applies to federal tax. State tax conformity is a separate analysis. Most states conform; some don't fully conform (see the state section below).

What Changed in 2018: Real Property Only

The Tax Cuts and Jobs Act of 2017 (Public Law 115-97, § 13303) amended § 1031 to limit its application to real property, effective for exchanges completed after December 31, 2017.

Before TCJA, a wide range of personal property could be exchanged under § 1031 — aircraft, equipment, artwork, livestock, franchise rights, and more. Those transactions no longer qualify. A net lease property can still be exchanged for another net lease property, an apartment building, raw land, a self-storage facility, or any other real estate held for investment. But an FF&E package or a business's goodwill no longer qualifies, which matters for certain hotel and operating-business transactions.

For net lease practitioners, the TCJA change is generally a non-event — net lease has always been real-property-driven. The main practical wrinkle is bifurcated sales: when a net lease sale includes meaningful personal property (signage, interior equipment, etc.) along with the real estate, the personal property portion of the purchase price is taxed immediately, and only the real property portion qualifies for deferral.

The Three Property Requirements

To qualify for 1031 treatment, both the relinquished property and the replacement property must satisfy three requirements:

1. Held for productive use in a trade or business or for investment

Neither property can be a primary residence, a vacation home held primarily for personal use, inventory held for sale (flippers, dealers), or property held primarily for resale. Intent matters. The IRS looks at facts and circumstances — how long the property was held, how it was used, and what the taxpayer's stated purpose was.

For net lease specifically, this requirement is almost always satisfied on both ends. Net lease property is by definition tenant-occupied real estate held for the rental income stream.

2. Like-kind

Treasury Regulation § 1.1031(a)-1 provides that all real property located in the United States is like-kind to all other real property located in the United States, regardless of grade or quality. An apartment building is like-kind to a Dollar General, which is like-kind to raw land, which is like-kind to an industrial warehouse. Foreign real property is not like-kind to U.S. real property.

Mineral rights, easements, and fractional interests in real property (tenancy-in-common and Delaware Statutory Trust interests) are also treated as real property for 1031 purposes under Treasury Regulation § 1.1031(a)-3.

3. Both properties must be exchanged (not sold then bought)

The transaction must be structured as an exchange — the taxpayer never takes constructive receipt of the sale proceeds. In practice, this is accomplished through a qualified intermediary (QI), who holds the proceeds between sale and purchase. If the taxpayer receives the proceeds, even momentarily, the exchange fails and the entire gain becomes taxable.

The 45/180 Day Timeline

Under Treasury Regulation § 1.1031(k)-1(b), a delayed (forward) exchange must satisfy two deadlines:

• 45-day identification period. Within 45 days after the transfer of the relinquished property, the taxpayer must identify potential replacement property in writing, signed by the taxpayer, and delivered to the qualified intermediary or another party involved in the exchange.
• 180-day exchange period. The replacement property must be acquired within 180 days of the transfer of the relinquished property, or by the due date (including extensions) of the taxpayer's federal income tax return for the year of the transfer, whichever is earlier.

Both clocks start on the same day — the date the relinquished property is transferred. There are no extensions except for presidentially declared disasters (where the IRS periodically issues relief).

The practical implication: if a relinquished property closes on October 15, the 45-day ID deadline is November 29, and the 180-day close deadline is April 13 of the following year. But if the taxpayer files their return on April 15 without an extension, the 180-day deadline effectively shortens.

The Three Identification Rules

Treasury Regulation § 1.1031(k)-1(c) provides three separate safe harbors for identifying replacement property. Taxpayers can use any one of them:

The Three-Property Rule

Identify up to three properties of any value. Most exchanges use this rule. If you identify three, you can acquire any one, two, or all three of them.

The 200% Rule

Identify any number of properties, provided the aggregate fair market value of all identified properties does not exceed 200% of the fair market value of the relinquished property. Useful when a taxpayer wants optionality across many smaller replacement options.

The 95% Rule

Identify any number of properties of any aggregate value, provided the taxpayer actually acquires at least 95% of the aggregate value of all identified properties. This is a backstop rarely used in practice because missing the 95% threshold triggers full tax on the exchange.

Identification requirements: property must be identified unambiguously — legal description, street address, or distinguishable name. "A property in Dallas" is not enough; "1234 Main Street, Dallas TX" is.

A taxpayer may revoke and re-identify properties during the 45-day window, but no changes are permitted after day 45.

The Qualified Intermediary Requirement

Because the taxpayer cannot take receipt of sale proceeds, the funds must flow through a qualified intermediary (QI) — an independent third party who holds the proceeds between sale and purchase.

Treasury Regulation § 1.1031(k)-1(g)(4) defines disqualified persons who cannot serve as QI: the taxpayer's attorney, accountant, investment banker/broker, or real estate agent or broker — generally, anyone who has provided services to the taxpayer in the two years before the exchange. Most QIs are independent specialty firms organized specifically to hold 1031 funds.

Several practical considerations:

• QI selection matters. QIs hold significant uninsured cash between closings. There is no federal regulation of QIs; several have failed historically, and client funds have been lost.
• Fees vary widely. Full-service QIs typically charge $1,000-$3,000+ per exchange depending on complexity, separate from any interest earned on funds held in escrow.
• Funds should be held in segregated accounts. Pooled fund structures have historically been a source of QI failure when the pool was invested in assets that lost value.
• Exchange agreement terms matter. The QI agreement controls how proceeds can be disbursed, what happens in the event of QI insolvency, and how interest earned is allocated.

Boot and Partial Deferral

If a taxpayer receives any non-like-kind consideration in the exchange — cash, debt relief in excess of debt assumed, or personal property — that consideration is called boot and is taxable to the extent of gain realized.

Two common boot scenarios in net lease exchanges:

Cash Boot

The taxpayer replaces a $3M relinquished property with a $2.5M replacement. The $500,000 difference, if taken as cash, is taxable boot. To fully defer tax, replacement property value must equal or exceed relinquished property value.

Mortgage Boot (Debt Relief)

The taxpayer sells a property with $1M of debt and replaces it with a property taking $700,000 of debt. The $300,000 net reduction in debt is treated as boot — the IRS considers debt relief equivalent to receiving cash.

To fully defer, the replacement property must have equal or greater debt than the relinquished property, or the taxpayer must add new equity to offset the reduction.

Related-Party Rules

Section 1031(f) imposes special rules on exchanges between related parties (as defined in § 267(b) or § 707(b)(1)): the exchange is generally disallowed if either party disposes of the exchanged property within two years of the exchange. The purpose is to prevent families and controlled entities from using 1031 to shift property and then immediately sell in a taxable transaction at someone else's basis.

Exceptions exist — the provision does not apply if the disposition is by reason of death, involuntary conversion, or a transaction that is clearly not tax-motivated — but the two-year holding period is strictly enforced in most practical contexts.

This matters particularly in family-held real estate and entity-to-entity exchanges within a sponsor's portfolio. Exchanges with unrelated third parties are not subject to the § 1031(f) rules.

State Tax Wrinkles

Federal treatment is uniform. State tax treatment is not.

California clawback. Under California Revenue & Taxation Code § 18032, if a California taxpayer exchanges California property for out-of-state property in a 1031 exchange, California requires annual informational reporting on the deferred gain and will tax the gain when the replacement property is eventually sold in a transaction that does not qualify for further 1031 treatment. Functionally, this means a California taxpayer cannot escape California source tax on the original gain merely by exchanging into another state.

Pennsylvania nonconformity. Pennsylvania does not follow § 1031 for personal income tax purposes. A Pennsylvania resident exchanging property will owe Pennsylvania personal income tax on the gain in the year of exchange, even if federal tax is deferred.

Other states have varying rules — Oregon, Massachusetts, and Montana have specific reporting requirements; some states conform fully but have their own technical provisions. State tax analysis should always be done alongside federal structuring, not as an afterthought.

Common Structures in Net Lease

Forward (Delayed) Exchange

The standard structure. Relinquished property sells first, proceeds go to QI, 45 days to identify, 180 days to close on replacement. This is the default for net lease exchanges.

Reverse Exchange

When the replacement property must be acquired before the relinquished property can be sold. The structure is governed by Revenue Procedure 2000-37, which established a safe harbor for exchange accommodation titleholder (EAT) arrangements — a separate entity temporarily holds title to the replacement property until the relinquished property can be sold, at which point the two legs are swapped.

Reverse exchanges carry the same 45/180 timing but running from the EAT parking date. They cost more (typically $15,000+) because of the entity structure, carrying costs, and legal complexity.

Delaware Statutory Trust (DST)

A DST interest is treated as a direct beneficial ownership in real property for 1031 purposes (Revenue Ruling 2004-86). A DST holds a single property or portfolio, and investors purchase fractional beneficial interests. Common for taxpayers looking for passive replacement property without active management obligations — many taxpayers complete 1031 exchanges into DSTs as a "set-it-and-forget-it" tax-deferred income investment.

DSTs carry liquidity and management constraints: the trust cannot renegotiate leases, refinance debt (with limited exceptions), or accept new capital contributions. These restrictions are what qualifies the DST as a real-property interest rather than a partnership interest for 1031 purposes.

Tenancy-in-Common (TIC)

An alternative to DST where investors hold direct, fractional undivided interests in the property as co-owners. Revenue Procedure 2002-22 sets out a safe harbor for when a TIC interest qualifies as a real property interest (rather than a partnership interest) for 1031 purposes — notably, maximum 35 co-owners, unanimous consent on major decisions, and no joint marketing as a partnership.

TIC structures are less common now than DSTs because of the unanimity requirements and the limit on co-owners, but they remain viable for closely-held exchange structures.

Practical Implications for Net Lease Investors

Several points specific to net lease:

Identification list sequencing matters. Most brokers representing a 1031 buyer will suggest listing the primary target first, then two backup options. If the target deal falls apart mid-exchange, the backups need to be real options — not placeholder properties.

Debt coverage is frequently the binding constraint. Investors exchanging a fully-amortized net lease into a newer, lower-cap property often find that replacement debt is lower than relinquished debt. Plan for mortgage boot or bring new equity to cover the gap.

Reverse exchanges are more common than many brokers realize. When a desirable net lease property comes to market and the investor doesn't yet have a buyer lined up for their current property, the reverse structure can preserve the opportunity. Costs $15K+ but often pays for itself in one successful deal.

DST offerings as identification backup. Many sophisticated 1031 exchangers identify a DST as their third property under the three-property rule as a "fallback." If the two primary targets fall apart, the DST closing is reliable (DSTs close quickly once subscriptions are placed), avoiding a failed exchange.

45-day identification ≠ 45-day diligence. Many investors treat identification as a commitment. It isn't. Identification is preserving optionality. Real due diligence and deal negotiation often extend past day 45. A diligent 1031 buyer identifies thoughtfully on day 44-45, not day 15.

Common Mistakes

• Letting proceeds pass through taxpayer accounts. Even a day of "constructive receipt" blows the exchange.
• Identifying a property that becomes unavailable. Once identified at day 45, no substitutions. If all three identified properties fall out of contract, the exchange fails.
• Missing state-level conformity issues. The California and Pennsylvania treatments listed above are the most common, but any cross-state exchange deserves a state tax review.
• Using a disqualified QI. Treasury Reg § 1.1031(k)-1(g)(4) bars the taxpayer's attorney, accountant, broker, or real estate agent from serving as QI if they provided services in the two years prior.
• Missing the related-party two-year holding period. Easy to overlook in family transactions; triggers full tax on the original exchange.
• Bifurcated sale personal property. A net lease deal with meaningful personal property inclusion (FF&E, signage valued separately) needs that portion carved out of the 1031 amount.

The Bottom Line

1031 is a mechanically simple statute enforced with extreme strictness by the IRS. The rules haven't changed materially in decades except for the TCJA-era real-property limitation. The most common reasons 1031 exchanges fail are not exotic legal edge cases — they are timing misses, boot that wasn't identified, QI issues, and state tax surprises.

Every net lease practitioner should have a working understanding of the mechanics because 1031 structuring affects the target list for every exchange buyer, the closing timeline, and ultimately the price a buyer can pay.

Editorial disclaimer. This article is published by Trestle Research for informational purposes only. It is not legal, tax, or investment advice. The rules described are current as of publication; readers should confirm current statute, regulation, and revenue procedure text before relying on any provision. Consult a qualified tax advisor or attorney on any specific 1031 exchange. Trestle is a technology platform, not a registered tax advisor, broker-dealer, or law firm.

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