Introduction
Sell a US property that has appreciated and the tax bill can arrive before the proceeds have even settled. A properly structured 1031 exchange may let qualifying proceeds stay invested instead.
Section 1031 is a US federal tax-deferral provision with strict rules on eligibility, documentation, timing and reinvestment. A missed deadline or a single touch of the sale proceeds can undo the benefit.
Australian investors face extra layers: Australian CGT, US withholding, currency records and entity reporting. This guide covers the core rules, the delayed-exchange process, the main risks and the Australian considerations.
Key Takeaways
- A 1031 exchange defers, rather than eliminates, US tax on qualifying real-property gains.
- Both properties must meet like-kind, qualified-use, ownership and timing tests.
- Engage a qualified intermediary before closing and never touch the proceeds.
- Australian investors need separate advice on US tax, Australian CGT, currency and reporting.
What Is a 1031 Exchange and Who Can Use It?
Under IRC Section 1031, no gain is recognised when real property held for productive business use or investment is exchanged solely for like-kind real property held for the same purposes. Since 1 January 2018, only real property qualifies.
Deferral, Not Elimination
The gain is postponed, not erased. The replacement property inherits the adjusted basis of the relinquished property, adjusted for money, liabilities and recognised gain. In the IRS illustration, investment real estate with a $225,000 basis is exchanged and the replacement basis stays at $225,000.
Depreciation adds a wrinkle. Unrecaptured section 1250 gain and some ordinary recapture can be recognised or carried forward under specific rules. A later taxable sale brings the deferred gain back into play, so never treat an exchange as a permanent saving.
Key Terms in Plain Language
- Relinquished property: the property you transfer first
- Replacement property: the property you receive later
- Exchange funds: money held by the intermediary between the two
- Like-kind: the same nature or character, not the same grade or quality
Improved and unimproved real property can be like-kind. Land, buildings and permanent structural components held for investment or business can qualify. Be aware that US property and property outside the US are not like-kind to each other.
Qualified Use and Exclusions
Both properties must be held for investment or productive business use. These generally do not qualify:
- A primary residence or other personal-use property
- Property held primarily for sale, including dealer inventory
- Stocks, bonds, notes and other securities
- Partnership interests
When an Exchange Makes Sense
Investors use exchanges to reposition a portfolio, consolidate management, change property type or preserve capital for another investment. Tax treatment should never override investment quality. A poor property bought only to defer tax is still a poor property.
The Core Rules Investors Must Follow
Same Taxpayer
The taxpayer who transfers the relinquished property must be the one who receives the replacement. US federal tax classification matters here. A US single-member LLC is disregarded unless it elects corporate treatment, while a multi-member LLC defaults to partnership treatment.
Partnerships, trusts, corporations and ownership changes all create complications. Rev. Rul. 2004-86 treats owners of certain grantor-trust interests as owners of the underlying real property, but it is not blanket approval for every trust structure.
The 45-Day and 180-Day Deadlines
Both clocks start on the transfer of the relinquished property and run concurrently:
- 45 days: identify replacement property, by midnight of day 45
- 180 days: receive it, by the earlier of day 180 or the due date (including extensions) of your US tax return for that year
Relief is narrow. Rev. Proc. 2018-58 can postpone deadlines by 120 days or more for qualifying disaster areas, and the IRS has issued location-specific relief, such as the notice for certain Mississippi taxpayers in 2026. It is not nationwide.
Identification Rules
Identification must be in writing, signed by the taxpayer and sent before the deadline. A legal description, street address or distinguishable name is enough. Use one of three conventions:
- Three-property rule: up to three properties, regardless of value
- 200% rule: any number, if total fair market value is no more than 200% of the relinquished property's value
- 95% exception: if both limits are exceeded, acquire identified properties worth at least 95% of the total value of everything identified
Boot and Partial Deferral
Full deferral generally requires reinvesting all equity and replacing the debt. Cash, non-like-kind property or net mortgage relief is "boot." Recognised gain is generally the lesser of realised gain and boot.
The IRS Form 8824 instructions give an example: $120,000 realised gain, $40,000 cash received, $40,000 recognised gain. The rest stays deferred.
Qualified Intermediary and Constructive Receipt
A qualified intermediary (QI) must be someone other than you or a disqualified person, engaged under a written agreement that limits your access to the funds. Disqualified persons include agents such as employees, lawyers, accountants and brokers who acted for you in the preceding two years.
Constructive receipt counts too. Money credited to you or otherwise available is receipt, even if you never hold it. Set up the QI before closing.
How a Delayed 1031 Exchange Works
Before You List or Close
Assemble your team early: a US tax adviser, a legal adviser, a lender, real estate professionals and a QI. Review ownership, basis, debt, estimated gain, costs and what you want in a replacement property.
Sale and Funds Control
Coordinate these documents so the QI, not you, controls the funds:
- Relinquished-property contract
- Assignment documents, with written notice to all parties on or before the transfer
- Exchange agreement with the QI
- Closing instructions sending proceeds to the QI
The QI may direct-deed the replacement property from its owner to you, so long as the exchange character remains.
Identification Stage
Prepare the written list with precise addresses or legal descriptions. Apply one of the three identification conventions (3-property, 200% or 95% rule). Keep proof of delivery and receipt.
Acquisition Stage
Buy only an identified property, within the deadline. Before closing, verify:
- Title and financing
- Debt replacement
- Closing costs
- That the buying entity matches the selling taxpayer
After Closing
File Form 8824 with the return for the year the relinquished property was transferred. It calculates recognised gain, deferred gain and replacement basis. Keep settlement statements and basis records. The IRS expects asset records until the limitation period expires for the year of taxable disposal. For Australian investors, those records also support ATO review.
Assessing Benefits, Risks, and When Not to Use One
Exchange Versus Selling
An exchange preserves capital for reinvestment but narrows your choices. You are working to a deadline, which can push you into a weaker property. A straight sale gives liquidity and flexibility, at the cost of current tax.
Weigh these factors:
- Transaction and advisory costs
- Concentration risk
- Financing needs
- Expected returns on the replacement property
Where Exchanges Fail
- Starting too late
- Missing the 45- or 180-day deadline
- Receiving proceeds directly
- Identifying a property that proves unavailable
- Changing the taxpayer
- Failing to replace debt
- Misunderstanding boot
Two cases show how unforgiving this is. In Rev. Rul. 2002-83, the taxpayer used a QI but bought from a related person who received cash. Nonrecognition was denied, and the taxpayer recognised $100x of gain. A QI cannot cure a related-party problem.
In a 2008 IRS advice memo, no replacement property was acquired within 180 days, so the intended deferral became recognisable gain.
When Not to Use One
Skip the exchange if you:
- Need the cash
- Cannot find a suitable replacement
- Want personal use of the property
- Face unacceptable market or financing risk
- Would pay disproportionate costs for a modest deferral
Australian Investor Considerations
Australian Tax Is Separate
A US 1031 exchange does not automatically defer Australian tax. The ATO's general position is that if you own an overseas asset, you may have to pay Australian capital gains tax when you sell it. No published ATO statement specifically addresses section 1031, so take advice before assuming any deferral.
- Foreign income tax offset: requires foreign tax actually paid. US nonrecognition is not tax paid.
- Treaty: Article 13 lets the country where the property sits tax the gain, and Article 22 gives Australian credit for qualifying US tax, subject to caps.
- Temporary residents: different rules apply.
Cross-Border Issues
- FIRPTA: buyers generally withhold 15% of the amount realised (not the gain) on sales by foreign persons.
- Withholding certificate: a nonrecognition notice cannot be used when a deferred exchange is incomplete by the Form 8288 deadline; file Form 8288-B instead.
- Filing: Forms 8288 and 8288-A are due within 20 days of disposition. File 1040-NR (individuals) or 1120-F (foreign corporations); an ITIN may be needed.
- State tax: California, for example, requires annual reporting of exchanges from California property into out-of-state property until the deferred gain is recognised.
- Entity reporting: US-created entities are now exempt from FinCEN beneficial ownership reporting, but qualifying foreign entities registered in the US remain covered.
- Currency: convert to AUD at the relevant transaction time. Keep CGT records for at least five years after the event.
Where VJM Global Fits
VJM Global is a chartered accountant firm that supports Australian businesses and investors with accounting, tax compliance and financial advisory, and has served 250+ Australian clients. That support can help coordinate cross-border records and compliance.
The exchange itself, legal structuring and tax determinations belong with a US qualified intermediary and licensed US and Australian tax or legal advisers. VJM Global does not provide legal or real estate brokerage services.
Frequently Asked Questions
What is a 1031 exchange and how does it work?
It is a US tax-deferral strategy where qualifying real property is sold and replaced with like-kind property. A qualified intermediary holds the proceeds, you identify replacements within 45 days and complete within 180 days.
What is a qualified intermediary?
An independent party, not you or your agent, that holds exchange proceeds and handles the documentation under a written agreement. Check its experience, safeguards and role before engaging it.
What is a delayed 1031 exchange?
You sell the relinquished property first, then acquire the replacement later. Identification and completion deadlines run from the sale transfer date.
What is the 2 year rule for 1031 exchanges?
It is not universal. Rev. Proc. 2008-16 is a safe harbour for dwelling units: 24 months before or after, with at least 14 days of fair-rental use and limited personal use each 12 months.
Do I have to spend all the money in a 1031 exchange?
No, but unreinvested cash or non-like-kind property is boot and triggers gain, up to your realised gain. The rest can remain deferred.
What is the 95% rule in a 1031 exchange?
It applies only if you identify more than three properties and exceed 200%. You must then acquire identified properties worth at least 95% of the total value of all identified properties.
