What Happens When You Sell a 1031 Exchange Property

A 1031 exchange is a savvy strategy for deferring taxes when swapping real estate. But questions often arise when an investor decides to sell a property acquired via a 1031 exchange. In this guide, we’ll go over the general timeline of what happens when you sell a 1031 exchange property as well as some key steps and concepts to keep in mind.

Here’s a quick overview on topics we’ll cover:

Depreciation & Recapture: Depreciation lowers basis; recapture is taxed at 25% after sale.
Capital Gains: Gains in excess of recaptured depreciation are taxed at 15–20%.
Boot: Any non-reinvested proceeds are taxable immediately.
Intermediary: Holds funds and facilitates compliant exchange.
Replacement Property: Must meet like-kind rules; choice affects future tax deferral track.
1031 Exchange Timeline: 45 days to identify, 180 days to close replacement.
Holding Period: No IRS rule, but 24 months widely considered sufficient to prove intent.
Tax Filing: Form 8824, 1099‑S required in year of sale or exchange.

What Is a 1031 Exchange?

A 1031 exchange, named after Section 1031 of the IRS Code, allows investors to defer capital gains tax and depreciation recapture when they reinvest proceeds from a sold “like-kind” property into another qualifying property. To qualify, you must follow certain rules, including strict deadlines: 45 days to identify replacement property and 180 days to close.

The typical 1031 exchange timeline flows like this:

Sell the relinquished property.
Have proceeds held by a Qualified Intermediary.
Identify a replacement property within 45 days.
Close on the replacement property within 180 days.
Defer tax on gains and depreciation so long as no boot is received.

What Happens When You Sell a 1031 Exchange Property?

A regular 1031 exchange can seem simple, but the process gets more complicated when you decide to sell or exchange the property you’ve bought as part of that original 1031 exchange.

When selling the replacement property that you acquired, that property now behaves like any other real estate investment, except for a few important considerations:

Your adjusted cost basis
Depreciation and recapture
Tracking of capital gains deferments
Qualified use

Calculating Adjusted Basis and Depreciation

Your adjusted cost basis equals what you originally paid for the relinquished property plus improvements and closing costs, minus any depreciation taken. That depreciation lowers your basis, which increases the gains realized at sale and sets the stage for potential recapture.

Capital Gains and Recapture

When you finally sell:

Capital gains = Sale price − Adjusted basis.
Depreciation recapture is taxed at normal rates.
You must track the capital gains from your previous 1031 exchanges, including the 1031 exchange of the initial relinquished property.

Qualified Use

One concern when selling what was originally a replacement property in a previous 1031 exchange is that, in order for the property to qualify as a relinquished property in this exchange, it must fulfill the IRS’ “qualified use” requirement.

Qualified use means that the property must be held solely for investment or business purposes. It cannot be a primary residence, for instance. As we will see, selling a 1031 exchange property quickly can trigger increased scrutiny over whether the qualified use requirement was truly met.

How Soon Can You Sell a 1031 Exchange Property?

A common question: how soon can you sell a 1031 exchange property without losing tax benefits? The IRS doesn’t specify a minimum holding period. However, there are some caveats to this.

Short holding periods (e.g., weeks or months) may trigger IRS scrutiny, as they suggest the replacement property might not have been intended for investment (potentially disqualifying it for a 1031 exchange).
To demonstrate intent, many advisors recommend holding the new property at least two years. While there is no “two year rule,” the IRS in one case considered 24 months a safe benchmark to prove qualified use.

Ultimately, selling a 1031 exchange replacement property soon after completing its initial exchange can cause several consequences, such as:

Recapture of previous depreciation.
Traditional capital gains tax on the difference between your basis and sale price.
Potential increased audit risk.

Tax Implications of Selling a 1031 Exchange Replacement Property

Let’s examine a few potential tax implications when selling a 1031 exchange property.

Depreciation and Recapture

Depreciation reduces your taxed income annually. When you sell the exchanged property, all accumulated real estate depreciation is recaptured and taxed up to 25%.

You must include this in your tax return for the year in which you sell the property.

Capital Gains

Remaining profit beyond recaptured depreciation is taxed at normal rates if you simply perform a traditional sale. However, if you do a new 1031 exchange, you can defer capital gains taxes on the sale of your property, as well as the depreciation recapture, and use the proceeds to purchase a new replacement property.

If you “boot,” or choose not to perform a new 1031 exchange, you would need to pay taxes on the capital gains you receive.

Strategic Considerations

So, what should you consider before deciding how to proceed with the sale of a property that was originally a replacement property in a 1031 exchange? We’ve compiled some strategic considerations to think about and discuss with your Qualified Intermediary before making your decision.

1. Tax Deferral vs. Cash Access

If it’s critical to unlock equity, a sale with boot may make sense even though you’ll have to pay capital gains taxes. Alternatively, consider a partial exchange or refinancing to pull out capital before selling.

2. Creating a Deferral Chain

You can continue doing a series of 1031 exchanges. When you do this, your deferred tax debt grows but is pushed further away. When you finally sell a property without performing a 1031 exchange, capital gains taxes come due.

3. Estate Planning Benefits

Inherited property receives a step-up in basis, wiping out deferred tax liability entirely. Many investors use this and other retirement strategies to avoid high taxes after years of deferral.

A Simple 1031 Exchange Property Sale Example

Let’s imagine a scenario to use as an example of how this process could play out in the real world.

You did a 1031 exchange in 2018, trading a $500,000 investment property for a $600,000 rental property. Over time, you took $150,000 in depreciation, lowering your adjusted basis to $450,000.

In 2025, you sell the rental property you originally purchased as a replacement property. You sell it for $800,000.

Depreciation recapture = $150,000 taxed at 25%: $37,500.
Total gain = $800,000 – $450,000: $350,000.
Capital gains beyond depreciation = $200,000 taxed at 15%: $30,000.

Taking both the depreciation recapture and capital gains, you now owe about $67,500 federal tax. That doesn’t include applicable state taxes. However, if you perform a 1031 exchange instead of an outright sale, you can defer those taxes as well as the capital gains tax you owe from the original 1031 exchange.

FAQs on Selling a 1031 Exchange Property

Below, we’ve compiled answers to some of the more common questions about what happens when you sell a 1031 exchange property.

What happens if I sell too soon after a 1031 exchange?

You may still owe recapture and capital gains taxes, and you risk IRS scrutiny. A short holding period can trigger suspicion that the exchange lacked genuine investment intent, which is required for a property to qualify for a 1031 exchange.

Can I do a 1031 exchange and then immediately sell?

Technically, yes. However, if you haven’t held the replacement property for long enough, your original exchange might be disqualified. This would trigger full tax on prior gains and depreciation. The IRS has no set rule for how long you must own the replacement property before you can sell, so it’s important to retain proof of genuine investment or business intent.

Do I lose my tax deferral if I sell my replacement property?

Not necessarily. You continue to defer capital gains taxes if you perform new 1031 exchanges each time you sell your property. You would lose tax deferral (and owe capital gains taxes on the chain of deferrals) if you sell without replacing the property. Another method of avoiding capital gains tax is a step-up in basis, which occurs when the property is inherited.

First American Exchange Company Can Help You Sell Your 1031 Exchange Property

Selling a property acquired via a 1031 exchange triggers a chain of tax implications, including capital gains taxes, depreciation recapture, and potential boot if you don’t reinvest fully. While the IRS imposes no minimum hold period, many economists and tax advisers recommend at least two years to validate investment intent. It’s best to consult with a Qualified Intermediary before making a decision to sell a property you’ve purchased as a replacement in a previous 1031 exchange.

Need help getting in touch with a Qualified Intermediary? Contact First American Exchange Company today to get started.