How to Prepare for a 1031 Exchange: A Step-by-Step Guide

Scott Ward, CFP®, AIF®, AIFA®, is a SVP, Wealth Advisor at Compound, where he specializes in helping real estate owners navigate 1031 exchanges to defer capital gains and maximize long-term wealth. He also advises executives and skilled professionals on retirement-transition strategies, executive benefits, portfolio management, and tax-smart planning for liquidity events.

If you’re building long-term wealth, real estate is still one of the best ways to do it. The U.S. housing market is worth approximately $55.1 trillion, and nearly 20% of single-family homes are owned by “mom or pop,” or individual investors. Home equity in combination with retirement accounts represents more than 60% of total household net worth.

But when it comes time to sell your investment property, going in without a strategy can cost you. Capital gains taxes can take a significant bite out of everything you’ve accumulated.

That’s why the 1031 exchange is one of the most powerful tools a real estate investor has. Done right, you can defer capital gains on a sale and keep that capital working. Done wrong, you're on the hook for the full tax bill anyway.

What most investors don’t realize: In a 1031 exchange you have 45 days to identify a replacement property and 180 days to close. Miss either deadline and you’ll owe the full capital gains bill you were trying to avoid. 

Here’s our 5-step guide to taking advantage of the benefits of a 1031 exchange, without the unintended consequences: 

Key Takeaways:
 
• Plan before the sale — clarify investment goals, assemble your advisory team, and understand replacement property options — to avoid rushed decisions.

• You have just 45 days from the sale to identify replacement properties and 180 days to complete the purchase.
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• Delaware Statutory Trusts can be a helpful tool for passive investments. 

Step 1: Get Clear on Your Goals BEFORE You Sell

You know you want to sell and swap, but have you thought about what you’re swapping for? Your next property = your next phase of investment.

Before moving forward, ask yourself:

• Is this about new income, growing current investments, or a balance of both?
• Do I want to stay hands-on or move toward passive ownership?
• Is diversification across geography, asset class, or tenants a priority?
• How does this investment fit into my long-term retirement or estate plan?

Don’t skip this foundational step. If you get too focused on tax deferral, you might end up buying a replacement property that doesn’t fit in with your lifestyle, timeframe, or risk tolerance.

Step 2: Assemble Your Team and Master the Timeline

Get your advisory team in place and understand the IRS requirements before your property goes under contract. If you wait, you'll make rushed, deadline-driven decisions. Reactive moves are rarely profitable ones.

“Advance planning plays a significant role in a successful 1031 exchange because the rules under IRC Section 1031 require the structure to be in place before closing, and the timelines begin immediately,” says Mike Willoughby, division manager for Asset Preservation, a qualified intermediary based in Roseville, California. “Investors who coordinate their tax strategy,financing, and replacement property options early tend to experience a smoother, more strategic exchange process.”

Include these key players early:

• Qualified Intermediary (QI) to facilitate the exchange
• CPA/tax advisor who knows 1031 rules inside and out
• Certified Financial Planner to align the transaction with your broader financial plan
• Real estate agent experienced in investment property sales

Know the IRS timelines cold

As of this writing, you have:  

• 45 days from the sale of your property to find a replacement property
• 180 days to purchase one or more of those properties

Your replacement property must qualify as "like-kind," meaning it's essentially similar in nature or character to the property you're selling (even if it differs in grade or quality).

How many properties you can identify in 45 days:

• Three-Property Rule: Up to three potential replacement properties, regardless of value.

• 200% Rule: Any number of properties, as long as their combined value doesn’t exceed 200% of the relinquished property’s sale price.

• 95% Rule: Any number of properties of any value, as long as at least 95% of the identified value is ultimately acquired.

Note that like-kind only applies to physical real estate — partnership interests, stocks, bonds, and foreign property don’t quality. When you keep a firm grasp on these guidelines, you can build a more flexible exchange strategy. 
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Step 3: Scout Replacement Properties Early

When you evaluate your property options early, you have time to plan for professional management, diversify your risk, and get access to pre-vetted, institutional-quality assets. 

That’s a good recipe for fast execution when the 45-day identification window starts.

All of the following count as like-kind property and qualify for a 1031 exchange: 

• Commercial real estate
• Delaware Statutory Trusts (DSTs)
• Residential rental or vacation properties
• Farmland
• Conservation properties
• Timberland investment properties

The Case for Delaware Statutory Trusts

A Delaware Statutory Trust (DST) lets you own a slice of a large, professionally managed property — an apartment complex, a medical office building, a warehouse, etc. — without any of the landlord headaches.

DSTs are typically pre-vetted and available before your property sale even closes. That means you can review your options, compare sponsors, and have replacements lined up before the 45-day clock starts. When the window opens, you're ready to move — not scrambling to catch up.

“If investors are nearing their 45th calendar day and aren’t sure if the property/properties they’ve identified will close, they could always list a DST on their identification form in case a hard asset purchase falls through,” comments Lauren Speidel, assistant vice president and regional manager for Exeter, a qualified intermediary based in San Diego, California. 

DSTs also take some of the financing complexity off your plate. They typically use non-recourse financing at the trust level, which simplifies debt replacement and removes the need for individual loan approvals.

💡 Non-recourse loans typically don’t require personal guarantees, making them even more attractive if you’re looking for a simpler process and less personal risk. (Note: While DSTs offer passive ownership and simplified financing, they are highly illiquid investments. Investors have no operational control over the property or management decisions, and as with all real estate, they carry the risk of loss of principal.)

Step 4: Calculate Your Cash Position (and Build a Safety Net) 

To defer capital gains taxes completely, you need to reinvest all your proceeds and maintain your current debt level — or add cash to cover any difference.

If you end up with any ash left over from the sale, that amount becomes taxable — known as ‘boot.’ Even a small gap can trigger a tax bill on the difference, which is why getting your numbers right before you close matters.

Covering that gap can be manageable when your finances are strong.. But it becomes harder when lending conditions tighten or timelines stretch. Be ruthlessly honest with yourself about your future cash flow needs and potential tax implications. If you can’t see the forest for the trees, get an advisor to help you formulate a multi-year plan. 

Delays Happen: Prepare for Them

 Even well-planned exchanges hit snags. A deal falls through or financing takes longer than expected or the right property isn’t available when you need it.

That’s why having a list of multiple replacement options identified before the 45-day clock starts matters. Consider whether a DST could work as a contingency if a direct acquisition falls through. A DST can serve as a contingency if a direct acquisition falls through — so your plan stays intact even when circumstances change. 

Step 5: Plan Your Exit Before You Enter

A 1031 exchange shouldn’t be a one-off. Every move you make here should reflect your long-term financial goals. 

Get clear on these before you make an exchange: 

• Expected holding period
• Liquidity needs
• Exit strategy
• Estate planning goals, including the potential for a step-up in basis

One thing to keep in mind: a 1031 exchange defers capital taxes, it doesn’t eliminate them. If you eventually sell the replacement property, without doing another exchange, that tax bill comes due.

But if you plan to leave the property to your heirs, the step-up in basis kicks in when you pass. That means they inherit it at its market value at the time of your passing, not what you originally paid. Because the cost basis resets, the deferred gains effectively disappear.

💡DSTs can solve estate planning headaches, especially when heirs prefer passive ownership rather than active property management.

Preparation Promotes Flexibility and Better Outcomes

The benefits of a 1031 exchange are huge: you get to keep your equity working for you rather than paying it out in taxes. But to do it right, you need to start planning long before you hang that “For Sale” sign. 

• Get clear on your goals. Have a clear understanding about your current financial picture, know the restrictions and timelines for an exchange, and assemble a team of experts to support you.
• Consider all your options, including DSTs. Used strategically, they can provide diversification, passive income potential, and critical flexibility during an extremely time-sensitive transaction.
• Future-proof your exchange. Make sure the replacement property you choose serves your needs for the long-term, and takes you one step closer to financial freedom.  

Remember, this is just one chapter in your wealth story. Don’t rush to the finish line because you’re afraid of tax consequences. There are bound to be unexpected delays or surprise left-turns. Plan well so that you can be flexible and pivot. 

FAQs

What happens if I miss the 45-day or 180-day deadline in a 1031 exchange?
‍Missing either deadline can disqualify your entire exchange, meaning you'll owe capital gains taxes on the sale of your property. There are no extensions, which is why advance planning and backup options are so critical.

‍Do I have to reinvest all the proceeds from my property sale to defer taxes?
‍Yes. If you receive any cash back, that amount becomes taxable. You'll also need to match or exceed the debt on your original property, either by taking on new debt or adding cash to make up the difference. Your tax advisor and Qualified Intermediary can help you structure the exchange to maximize tax deferral.

‍What is a Delaware Statutory Trust (DST) and when should I consider one?
‍A DST lets you purchase fractional ownership in large, professionally managed commercial properties — like apartment buildings, medical offices, or industrial facilities — without landlord responsibilities. DSTs can be particularly useful when you're looking to transition to passive ownership, need a backup option during the tight 45-day identification window, or want to diversify across multiple properties. 

Plan your next exchange with smarter insights. Model 1031 scenarios and stress-test replacement property options against your broader portfolio — all in the Compound dashboard.