Replacement Property for a 1031 Exchange

To defer taxes with a 1031 like-kind exchange, you have to be prepared to move quickly. Taxpayers have only 45 days from the date they close on the sale of their relinquished property to identify potential replacement properties for their exchange, and an additional 135 days, 180 days in total from the sale, to actually acquire their replacement property. Having a good idea about what you want to purchase as replacement property before you close on your sale will help ensure that you can timely complete your exchange.

There are a variety of replacement property options to allow you to complete your exchange, including some available on short notice. While it is common for investors to seek a new property similar to the type they sell, it is not a requirement. The concept of ‘like-kind’ under section 1031 of the Internal Revenue Code is broadly construed. All types of business or investment real estate are generally exchangeable for any other.

For example, you can exchange across asset classes, such as an apartment for a commercial building. It is also possible to exchange one large property for 2 or more smaller ones, or vice versa. Many people take advantage of this flexibility to swap management-intensive properties with tenants, toilets and trash for property with a single commercial tenant or a passive investment managed by others. This article explores some less obvious types of real estate that qualify for 1031 exchanges, as well as a handful of real estate investments that are not considered real estate for 1031 purposes.

Understanding the Basics

As you are looking for replacement property, keep in mind that the presence or absence of mortgage debt may impact what is most suitable for you.  In order to completely defer taxes with an exchange, the fair market value (FMV) of what you buy as replacement property must be greater than or equal to the purchase price paid by your buyer. If the property you are relinquishing has a mortgage, you will need to either acquire replacement property with a mortgage of greater or equal amount or contribute additional equity, or you may be liable for taxable ‘boot’ on the exchange.

Here’s an example:

You own property worth $1 million with a $400,000 outstanding mortgage balance. When you sell the property, you pay off your mortgage, and $600,000 goes to your qualified intermediary for your exchange.  If you use the $600,000 to buy replacement property on an all-cash basis, the fair market value (FMV) of your replacement property is only $600,000, and you will pay taxes attributable to the $400,000 mortgage debt you did not exchange. The $400,000 is considered taxable ‘boot’.  See Option A below. 

If, however, you buy replacement property with a loan-to-value of 40% or more, you will have at least $1 million of replacement property and the opportunity to completely defer your taxes. See Option B.

The most common form of replacement property is sole ownership property, where the taxpayer buys a fee simple interest in an asset in its entirety.  This can be a residential unit, a commercial property such as a retail, office, or industrial building, farmland, or raw land.  Fortunately, this is not the only alternative. There are many options for taxpayers who have insufficient funds to buy a suitable replacement property outright, do not want the burdens of management, want to diversify their investment, or want liquidity in the near future.

Delaware Statutory Trust (DST)

The Delaware statutory trust (DST) has become one of the most popular alternatives for 1031 replacement property. Investors in a DST acquire beneficial interests in a trust that owns a larger property or properties. Over $8.4 billion of equity was invested in DSTs in 2025  (Mountain Dell Consulting, 1031 DST/TIC Market Equity Update 12/31/25).

The DST market is robust, covering a full range of asset classes, varying degrees of leverage, and locations nationwide. There are typically around 50 different DST investments open for investment at any given time. DSTs typically have a single asset as the underlying investment, such as an apartment complex, an industrial facility, a shopping center, hotel or retail store, or an office.  Some DSTs include a portfolio of investments of a single type (i.e., medical properties or retail stores), and others are comprised of a diversified portfolio of assets, potentially located in multiple states.

While the underlying assets offered in DSTs may vary, the rules governing how they operate do not. DSTs are purely passive from the investor point of view. They are managed by a sponsor, a company with experience owning and operating the type of asset in question, and make regular distributions of cash flow.  The owned property is usually of institutional quality. Investors do not have any personal liability for the operations of the property or for payment of any mortgage debt that may be associated with the investment. DSTs can therefore be a good solution for investors who want to avoid the hassles of property management.

Another advantage of DSTs is that they can accommodate a wide range of economics. DST sponsors will allow 1031 investors to invest odd dollar amounts, representing the full amount of equity in their intermediary accounts. Additionally, DSTs are available with a wide range of leverage, allowing investors to acquire property of greater value without having to take out personal loans. The majority of DSTs include moderate leverage, but there are also debt-free DSTs with no mortgage loan, as well as ‘zero cash flow’ DSTs with leverage of 75% or more. Investors with larger exchanges may be able to diversify into multiple DSTs to achieve a level of leverage to suit their needs.

DSTs do, however, have some limitations. Most notably, DSTs are illiquid. The sponsor controls how long the investment property will be held in its sole discretion, usually 5-10 years. There is no well-established secondary market for DST interests if an investor seeks an early exit, and the limited buyer pool demands a substantial discount. Additionally, the DST structure does not allow the trust to refinance mortgage debt, bring in new investment capital after the offering period has expired, make significant capital improvements, or enter into new leases unless a tenant has gone bankrupt. While there are ways for the DST sponsor to navigate around some of these restrictions, those solutions may be costly or take time to execute, and may delay the time frame for exiting the investment. Investors do not have any say in operational or management decisions.

The overwhelming majority of DSTs are available only to accredited investors. Typical DSTs have a minimum equity investment of $100,000, subject to the discretion of the sponsor.

Over the past few years, there have been an increasing number of DSTs that include a ‘721/ UPREIT’ option. These investments begin as DSTs, but after a period of two or more years, the sponsor contributes the underlying DST asset to a real estate investment trust (REIT) that it owns. A REIT is a fund of real estate investments that may include real estate, mortgage loans, and other real estate-related assets. Investors may or may not have the opportunity to exchange out of the DST investment before the asset is transferred to the REIT. Investors who participate in the UPREIT receive shares in the REIT in exchange for their beneficial interests in the DST. There is no tax assessed upon conversion to the REIT, but a sale or redemption of REIT interests, or the REIT’s sale of the underlying investment property, will trigger a realization of the deferred taxes and gains, and the investor will be ineligible to do another 1031 exchange with REIT shares.

The primary benefits of investing in a DST with an UPREIT feature are that they offer a potential liquidity mechanism via redemption of REIT shares and diversification because the REIT will own a large pool of assets instead of a single property. The sponsor will indicate the conditions for redemption up front. However, the cost to participate in an UPREIT is high. The investor must first pay the fee load associated with the DST itself and then pay the ongoing annual fee load associated with the REIT. And as noted above, an investor cannot do a subsequent 1031 exchange after their real estate interest is converted to REIT shares. For this reason, some tax experts have questioned whether a DST with a mandatory UPREIT feature should be considered a valid purchase of real estate under section 1031 of the tax code or the purchase of a security.

Tenancy In Common (TIC)

Tenancy in common (TIC) is a form of ownership with up to 35 owners where each owner has a fractional, undivided interest in the entire property.  Each owner’s percentage ownership interest is reflected in the title to the property. The individual TICs share tax and other financial attributes of the investment in proportion to their percentage ownership interests. Each TIC has a ‘say’ in major decisions regarding the property.

The use of TIC structures for 1031 exchanges accelerated in 2002 when the IRS issued a Revenue Procedure (2002-22) providing guidance about when a TIC interest qualifies as replacement property for an exchange. Importantly, the IRS noted that the property must be managed in a way that treats each individual TIC as a decision-making owner rather than like a partnership where a small number of parties may make all important decisions. Allocations of expenses, income, and any mortgage debt must be proportional to each TIC’s deeded ownership interest. A sponsor or manager may receive a fee for its work, but it cannot receive a disproportionate share of capital event proceeds such as a carried interest or promote.

The various TICs must unanimously agree to all major decisions regarding the property, including leasing, management, capital projects, a potential sale, or taking out a mortgage loan. For this reason, there is usually a co-ownership agreement among the TICs to ensure cooperation in this regard and to address how the property will be operated.

TICs are offered for 1031 investors by professional real estate sponsors, who will prepare an offering memorandum for the investment and manage the TICs. Because of the need for unanimous consent on major decisions, as well as constraints imposed by mortgage lenders, most commercial TICs will have far fewer than the 35 permitted investors. For this reason, the minimum investment amount for a TIC is often $500,00 – $1 million or more, as compared to $100,000 for a DST.

Other Replacement Property for 1031 Exchanges

While DSTs and TICs represent the lion’s share of passive 1031 replacement property investments, there are other types of fractional interests that can help you complete an exchange. These include interests in natural resources such as oil, gas, and minerals, as well as interests in long-term ground leases. Further, investors have the ability to flip the process and acquire replacement property before they sell their relinquished property (a reverse exchange) as well as to build or rehab their replacement property during the 180-day exchange period (an improvements exchange).

Natural Resource Investments

Deeded interests in oil, gas, and mineral rights (as contrasted to interests in a company that owns or operates drilling or mining operations), for example, can be used as 1031 replacement property. The income stream is derived from the raw materials produced by the mining or drilling operations and varies based on the output and price of the commodity in question, offering diversification from the economics of the real estate market, and often a significantly higher cash flow yield. However, unlike an investment in a traditional rental property that has upside potential upon sale, the value of a well or mine will eventually go down to zero as the natural resource is depleted. Thus, instead of deductions for depreciation, a significant benefit to real estate investors in general, investors in natural resources may claim depletion deductions on their tax returns. Investors should conduct thorough due diligence on the anticipated useful life of the wells or mines before making this type of investment.

Another important feature of oil, gas, and mineral investments is that the interests are unlevered; they will not have mortgage loans. If you are selling a property that has a mortgage, you will need to either pair an energy or mineral investment with another replacement property that has debt or contribute additional equity to completely defer your taxes.

Long-Term Ground Leases

A ground lease is a long-term lease agreement for unimproved land, usually lasting 50 to 99 years. The tenant leases the property and then has the right to develop it and construct improvements, such as a commercial or residential building, for the duration of the lease term.  At the end of the lease term, the landlord will own the improvements. The tenant benefits from a ground lease by not having to pay up front for the cost of the land. The landlord benefits from the rental income without having to take on construction or development.

Interests in ground leases of 30 years or more qualify as replacement property for a 1031 exchange. The 1031 exchange transaction for the development of a building on a ground lease is called a leasehold improvement exchange, and it requires the assistance of a sophisticated qualified intermediary. Unlike the other options for fractional ownership described here, which are passive, acquiring a ground lease interest requires substantial time, energy, and expertise to develop the property. It is also possible to exchange into a ground leased property that has already been developed. This is a more passive way to invest. The buyer of the ground lease interest may get a more attractive purchase price up front, but will have to work with the ground owner and any building tenants (if the building is rented to a third party) to ensure the terms of the respective leases are satisfied.

Real Estate That Does Not Qualify for an Exchange

Finally, it is essential to keep in mind that not all real estate investments will qualify as replacement property for a 1031 exchange. The key is the way in which the investment is structured. Investments that are, or resemble, a security or other personal property are not considered ‘like kind’ for 1031 exchange purposes.

Interests in real estate funds and investment trusts (REITs) can never be considered replacement property for a 1031 exchange. Rather, these investments are deemed securities by the IRS rather than real estate interests. This is especially important if you exchange into a DST that subsequently contributes its assets to a REIT and converts your interest in a DST to REIT shares (an UPREIT transaction).  Your 1031 exchange into the DST may be valid, but you will not be able to do a subsequent exchange of the REIT shares because the shares are personal property rather than real estate.

An interest in a partnership or LLC that owns real estate similarly does not qualify as 1031 replacement property. Thus, if you invest with partners or a professional sponsor to buy a property in a partnership or LLC, you are acquiring a membership or partnership interest in the company that owns real estate rather than a direct interest in the real estate yourself, even if the investment has other attributes of property ownership such as pass-through depreciation. Note that an LLC or partnership itself can do an exchange if the entity is selling and buying the real estate directly; it is the individual interests of the investors that cannot be exchanged under section 1031.

There are other real estate investments that provide tax benefits similar to those offered by section 1031, including deferral or gains or a step-up in cost basis. An investment in a Qualified Opportunity Zone fund (QOZ) is an example. QOZ Funds invest in real estate located in specifically designated census tracts, and offer a possibility of tax deferral and partial forgiveness of prior capital gains if you invest long-term.

Conclusion

In sum, there are many options available for replacement property to complete a 1031 exchange. Getting your tax, legal, and/or financial advisor involved early on in the process is essential to ensure you can make an informed decision in the relatively short time frame allotted for the transaction.

[Editors’ Note: To learn more about this subject, watch Valuing Real Estate Assets and Ethical Issues In Real Estate-Based Bankruptcies / Insider Lease Agreements, each a free on-demand webinar.

This article was originally published on January 21, 2026.]

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