Qualifying for a 1031 Exchange: Common Mistakes to Avoid

Navigating a 1031 exchange? Avoid these common mistakes to keep your tax deferral intact.

While a 1031 exchange can defer capital gains taxes, the rules are strict. Missteps with timelines, property value, or fund handling can lead to disqualification. Careful planning helps avoid them.

This guide will help you steer clear of the most frequent pitfalls that could jeopardize your eligibility for a 1031 Exchange.

What is a 1031 Exchange?

A 1031 exchange is a tax strategy under Section 1031 of the Internal Revenue Code. It allows investors to defer capital gains taxes when selling a business or investment property. To qualify, the proceeds must be reinvested into a like-kind property of equal or greater value. It helps investors grow their wealth by keeping gains in a tax-deferred state.

Common mistakes to avoid 

Mistake #1: Not using a Qualified Intermediary (QI)

A Qualified Intermediary (QI) is a neutral third party. They are required for a valid 1031 exchange. The QI holds the sale proceeds and uses them to buy the replacement property. This keeps the process in line with IRS rules. 

If you access the funds yourself, the exchange no longer qualifies. That means you’ll owe capital gains taxes right away. Not using a QI can turn a tax-deferred opportunity into a taxable mistake. Always work with a QI who specializes in 1031 exchanges.

Mistake #2: Not sticking to the timeline

It is imperative to follow the 45-day and 180-day timelines. A 1031 Exchange strictly enforces a 45-day identification period, during which the investor must identify potential replacement properties. Additionally, you have 135 days to close on the purchase of the replacement property.

If you miss any part of the timeline, you forfeit the opportunity to receive tax deferral benefits.

The IRS provides three identification rules—the 3-Property Rule, 200% Rule, and 95% Rule—to guide the selection of new investments. These rules are designed to offer flexibility in your property choices. If something goes wrong with your first option, you’ll have backups ready. However, these timelines must be strictly adhered to.

• 3-property Rule - The 3-Property Rule in a 1031 exchange lets you list up to three potential replacements, offering flexibility if one falls through. However, if none are acquired within 180 days, you lose tax deferral benefits.
• 200% Rule -The 200% Rule in a 1031 exchange lets you identify unlimited replacement properties, as long as their total value doesn’t exceed 200% of the sold property’s value. For a $500,000 sale, identified properties can’t exceed $1 million to maintain tax deferral eligibility.
• 95% Rule - The 95% Rule in a 1031 exchange allows unlimited property identification with no value cap, but you must acquire at least 95% of the total value to qualify. It’s most effective when buying a full portfolio from one seller, provided all IRS requirements are met.

Mistake #3: Incorrectly identifying replacement property

Finding the right replacement property is essential to qualify for a 1031 Exchange. The property must be “like-kind”—not necessarily identical, but it must be held for business or investment purposes. Residential property held for personal use does not qualify under this category.

A trustworthy Qualified Intermediary (QI) can assist you in finding the right property. Keeping the three identification rules in mind can also help you make the most of a 1031 Exchange. This guidance is not based on your capital gains situation.

Mistake #4: Incorrect Ownership Structures

Owning property through partnerships or LLCs without proper planning can disqualify your 1031 Exchange. The IRS requires the same taxpayer to sell and buy. If it happens that partners split or restructure ownership mid-exchange, you risk losing deferral benefits. 

A Delaware Statutory Trust (DST) can be used as a 1031 replacement property, offering fractional ownership in institutional-grade real estate, and is often suitable for those seeking to move toward passive ownership.

Alternatives like DSTs (Delaware Statutory Funds) offer flexibility. They let investors part ways or reinvest individually if a need emerges mid ownership. It helps you stay compliant and protect your tax advantage.

Note: If a property is owned through a partnership or LLC, and one or more partners want to cash out or change ownership before reinvesting then a properly planned drop out or conversion to TIC/DST must be done in advance.

Mistake #5: Documentation and Form errors

Proper documentation and adherence to the timeline are non-negotiable to qualify for a 1031 Exchange. Some of the key documents include the signed sales contract, completed 1031 Exchange information sheet, exchange agreements, settlement statements, and documentation related to closing day and escrow setup.

Note: You must seek assistance from your Qualified Intermediary (QI) in preparing these documents to avoid any errors.

Mistake #6: Identifying just one property - must identify 3-4 properties

Limiting yourself to just one replacement property during a 1031 Exchange is risky. If that deal falls through, you could lose your eligibility for tax deferral. The IRS allows you to identify up to three properties—take advantage of that flexibility. 

Identifying 3–4 options provides a safety net and increases your chances of successfully completing the exchange within the strict timeline. Always plan for backups.

Mistake #7: Debt Replacement Mistakes

Many believe you must match or exceed the loan amount from the sold property. That’s false. The key is replacing the value of the debt—not the loan itself. If you had $400,000 in debt, you can replace it with cash, seller financing, or private funds. 

Using less than the full value can trigger taxes. Don’t assume another loan is your only option. Mixing funding sources is fine. Always consult a tax professional to avoid costly mistakes and ensure full tax deferral.

Ready to start your 1031 Exchange Journey

Successfully qualifying for a 1031 exchange often comes down to following key IRS rules—such as meeting strict timelines, choosing eligible properties, and using a qualified intermediary. Paying close attention to these requirements can greatly improve your chances of deferring taxes and preserving your investment gains. 

With careful preparation and informed decisions, investors put themselves in a strong position to meet 1031 exchange criteria. For those exploring this route, understanding the process can be a valuable first step toward potential tax deferral benefits.

If you’re ready to start your 1031 exchange journey or need expert advice, get in touch with us today!