1031 Exchange Rules: Complete IRS Guide for LA Investors

⚠️ IMPORTANT LEGAL DISCLAIMER

This article provides general educational information about IRC Section 1031 exchanges and is not tax, legal, or financial advice. IRS rules are complex and fact-specific. Always consult a qualified tax advisor, CPA, or attorney before executing a 1031 exchange. Justin Borges is a licensed California real estate broker (DRE #01940318), not a tax professional or attorney.

A 1031 exchange requires sellers to: (1) use a Qualified Intermediary to hold the sale proceeds, (2) identify replacement properties in 45 days, (3) close on one or more of those properties within 180 days, and (4) reinvest into like-kind investment property. Missing a deadline, taking possession of the sale proceeds, or purchasing a non-qualifying property invalidates the exchange and triggers full tax liability.

4 Non-Negotiable IRS Requirements

1. Qualified Intermediary must hold all funds — You cannot touch sale proceeds at any point
2. 45-day identification deadline — No extensions, no exceptions, measured from closing date
3. 180-day closing deadline — Counted from the same closing date, not an additional 180 days
4. Like-kind investment property only — Must demonstrate investment intent through holding period and operation

These Rules Are Strict — And Los Angeles Makes Them Even More Important

If you're an investor in Los Angeles, you already know things are complicated here:

• RSO (Rent Stabilization Ordinance)
• JCO (Just Cause for Eviction Ordinance)
• AB 1482 (California Tenant Protection Act)
• Tenant protections that make turnover nearly impossible
• Below-market rents locked in by rent control
• Eviction restrictions that prevent removing problem tenants

All of that makes a 1031 exchange one of the most important wealth-preservation tools you have left. But it only works if you follow the IRS rules exactly.

There are no extensions. No exceptions. No "my lender delayed me." No "I couldn't find something in time."

A 1031 exchange is an IRS clock — and the clock does not stop for anyone, anywhere, under any circumstance.

This guide breaks the entire process down step-by-step, in plain English, using real-life LA investor scenarios.

SECTION 1 — The 4 Core Rules You Must Follow (Or the Exchange Dies)

The IRS only cares about four things.

Rule 1 — You must use a Qualified Intermediary (QI).

This is mandatory.

A QI (also called an accommodator):

• Holds your sale proceeds in a segregated account
• Prepares exchange documentation
• Ensures IRS compliance throughout the transaction
• Sends funds directly to escrow for the replacement property
• Keeps you from touching the money

If you touch the funds?

The exchange is dead — instantly.

Even if the money sits in your account for 5 seconds, it counts as constructive receipt and the IRS considers it a taxable sale.

You cannot use:

• Your CPA
• Your attorney
• Your real estate agent
• Your spouse
• Your business partner

A QI must be a neutral third party with no prior relationship to you (with narrow exceptions defined in IRC regulations).

Rule 2 — You must identify replacement properties within 45 days.

This is the famous 45-day rule, and it catches more LA investors than anything else.

The clock starts:

The moment your downleg closes escrow.

Not the listing date. Not the offer date. Not the day you decide to exchange.

The closing date. Day 1 is the next day.

You get 45 calendar days, weekends and holidays included.

Your identification must be:

• In writing
• Unambiguous (typically the property address and/or legal description)
• Delivered to the QI before midnight on Day 45 (not your agent, not your CPA)
• Signed by you or your authorized representative

You cannot change your identification after Day 45.

No exceptions. No extensions. No "but the seller countered."

Whatever is on that list on Day 45 becomes your universe for the next 135 days.

This is why I always tell clients:

"You should be identifying uplegs before we even list your property."

💡 Pro Tip: I provide clients with a "Day 45 Identification Checklist" that prevents the email-to-wrong-person disaster. Download the free checklist

Rule 3 — You must close on a replacement property in 180 days.

The 180-day rule runs concurrently with the 45-day rule.

It is not 45 + 180. It is 180 days total from closing.

To be clear:

• Identify by Day 45
• Close by Day 180
• Day 1 = the day after your downleg closes
• No extensions. Not for banks, lenders, sellers, holidays, or natural disasters.

If you do not close by Day 180?

Your exchange fails and becomes a fully taxable sale.

Last month I had a client miss Day 45 by 3 hours because they emailed their identification list to their real estate agent instead of the QI. The agent forwarded it the next morning. Too late. $180,000 tax bill. This is why I build identification checklists and deadline tracking into every single exchange engagement.

Rule 4 — You must reinvest into "like-kind" investment property.

Many people misunderstand this. "Like-kind" does not mean same type.

It is very flexible.

You can exchange:

• Duplex → 10-unit apartment building
• Single-family rental → industrial warehouse
• Office building → land held for investment
• 4-unit RSO property → DST (Delaware Statutory Trust) portfolio
• Triplex → multiple single-family rentals
• Commercial → multifamily

You cannot exchange:

• Primary residence → rental property
• Flip property (inventory) → rental
• Rental → property you immediately move into
• Rental → second home for personal use
• Rental → property intended for resale
• US property → foreign property (or vice versa)

The property must be acquired with investment intent, which the IRS evaluates based on:

• Holding period before and after the exchange
• Lease activity and rental income documentation
• Depreciation deductions taken
• Business purpose documentation
• Overall facts and circumstances of your situation

While the IRS has not published a specific minimum holding period requirement, most tax professionals recommend holding investment property for at least 1–2 years before and after an exchange to demonstrate investment intent. Case law shows variations based on individual circumstances. Consult your CPA or tax attorney for guidance specific to your situation.

📊 The Exchange Analysis Spreadsheet (Free Tool)

Before every 1031 exchange, I run clients through this calculation framework:

• Current property basis and accumulated depreciation
• Estimated capital gains (federal + CA state + recapture)
• Net proceeds after taxes vs. 1031 deferral
• Replacement property cash flow projections (without RSO restrictions)
• 5-year wealth comparison: sell and pay taxes vs. exchange and compound

Example: On a $1.8M sale with $600K in gains, this spreadsheet shows the difference between walking away with $1.08M (after 40% tax hit) versus reinvesting $1.8M into cash-flowing properties.

→ Get your free Exchange Analysis Spreadsheet

SECTION 2 — The Full IRS 1031 Exchange Timeline (Explained Simply)

Let's walk through exactly what happens, step by step.

STEP 1 — Pre-Planning (This is where LA investors win or lose the exchange)

If you wait until you close escrow, you are already behind.

In Los Angeles especially — where rent caps and tenant issues can tank timelines — the exchange has to be planned before you list.

During pre-planning we:

• Analyze your Schedule E for cash flow and tax basis
• Run the Exchange Analysis Spreadsheet to project outcomes
• Identify profitable upleg opportunities
• Contact lenders early for pre-approval
• Build timeline extensions into the downleg sale contract
• Position your sale to create negotiating leverage
• Build buffer time in case buyers demand repairs or concessions

This is where most LA investors get it wrong — they list first, plan later.

STEP 2 — You enter escrow on your downleg

This is the property you're selling (the "relinquished property" in IRS terminology).

During this window, we:

• Coordinate with your Qualified Intermediary
• Prepare and execute exchange assignment agreements
• Narrow down upleg options based on market conditions
• Get financing pre-approvals finalized
• Start due diligence NOW, not after you close

By the time you're closing your downleg, we ideally already have:

• 3 potential uplegs identified
• Offers submitted or in negotiation
• Purchase agreements in hand
• A clear winner emerging

STEP 3 — Your downleg closes: the IRS clock starts

The next day is Day 1.

Your QI holds your money in a segregated account. You cannot access it.

You now officially have:

• 45 days to identify replacement properties
• 180 days to close on one or more of them

This is the most stressful period for unprepared investors and the easiest period for prepared ones.

STEP 4 — Day 1–45: Identify replacement properties

You must submit your identification list using one of the 3 IRS identification rules:

1. Three-Property Rule — Identify up to three properties of any value

2. 200% Rule — Identify more than 3 properties, as long as their total fair market value does not exceed 200% of the relinquished property value

3. 95% Rule — Identify any number of properties of any total value, but you must close on properties representing at least 95% of the total identified value

Most LA clients use the Three-Property Rule.

It's safer. Cleaner. More predictable.

Your identification must be delivered to your QI in writing before midnight on Day 45. Email with read receipt is acceptable. Certified mail works. Text message does not.

STEP 5 — Day 1–180: Close on the replacement property

You can close on one or multiple properties, but they:

• Must be on your Day-45 identification list
• Must close by Day 180
• Must qualify as investment property
• Must be purchased using QI-held exchange funds
• Must match the exchange structure documented in your paperwork

If anything closes after Day 180 — even by one hour — the exchange fails.

There are no IRS hardship exceptions. Not for wildfires, not for pandemics, not for lender delays.

📅 Timeline Tool: Want to see your exact Day 45 and Day 180 deadlines? Use the free 1031 timeline calculator

STEP 6 — Complete the exchange: The QI transfers funds

Once the replacement property (or properties) close escrow:

• QI sends exchange funds directly to the closing escrow
• Exchange documentation is finalized and recorded
• You receive a 1031 exchange summary statement for your CPA
• You begin a new depreciation schedule on the replacement property
• You move forward with the new investment

You've officially deferred capital gains taxes and preserved your wealth to reinvest.

SECTION 3 — What Happens If You Break Any IRS Rule? (The Hard Truth)

If you:

• Miss Day 45
• Miss Day 180
• Touch the funds (constructive receipt)
• Identify properties incorrectly
• Buy a non-qualifying property
• Fail to close on 95% of identified value (if using that rule)
• Use an unqualified intermediary
• Convert the property to personal use immediately

The exchange fails.

And when it fails, the IRS treats the sale as:

• A fully taxable event
• Subject to federal capital gains tax (0%, 15%, or 20% depending on income)
• Subject to depreciation recapture (25% federal rate)
• Subject to California state capital gains tax (up to 13.3%)
• Potentially subject to Net Investment Income Tax (3.8% Medicare surtax)

In Los Angeles, this can easily wipe out 30–40% of your sale proceeds.

There is no appeal process. No hardship exceptions. No IRS forgiveness program for missed deadlines.

Timing is absolute.

⚠️ What Most 1031 Advisors Get Wrong About LA Exchanges

National QIs and CPAs treat LA like any other market. They don't account for:

• RSO properties taking 60-90 days to close (not the standard 30-45)
• Rent control making appraisals unpredictable and killing financing
• Buyers demanding tenant estoppels on properties with JCO protections
• Deferred maintenance issues common in pre-1978 LA buildings

I've seen investors lose exchanges because their out-of-state advisor didn't build LA-specific buffers into the timeline. In this market, generic 1031 advice is expensive advice.

SECTION 4 — Why These Rules Hit Los Angeles Investors Hardest

Because LA adds layers of complexity that other markets don't face:

1. RSO makes turnover nearly impossible → Harder to increase property value before selling

2. JCO restricts evictions → Harder to remove problem tenants who damage property or scare buyers

3. Below-market rents create distorted valuations → Properties with $1,200/month rent control may appraise far below market comparables at $3,500/month

4. High prices limit replacement property options → Selling a $2M duplex means finding $2M+ replacement properties in 45 days

5. Older building stock means surprise repairs → Inspections reveal foundation issues, unpermitted work, deferred maintenance that kill transaction timelines

6. Competitive markets mean backup offers → Sellers receive multiple offers and may not accommodate your 1031 timeline needs

LA investors are operating with constraints most markets don't have — so the IRS constraints become even more critical to navigate properly.

SECTION 5 — This Is Why I Tell Clients: "The Exchange Starts Before You List."

Your biggest advantage in a 1031 exchange is preparation.

When you:

• Identify upleg targets early
• Negotiate purchase agreements early
• Pre-approve financing early
• Build timeline extensions into your downleg sale contract
• Create competitive bidding situations to control closing dates
• Have backup properties for your backup properties

Your 1031 becomes smooth. And predictable. And profitable.

When you wait?

You're hoping the IRS gives you grace.

It won't.

SECTION 6 — When DSTs Make Sense for LA Investors

Delaware Statutory Trusts (DSTs) are fractional interests in institutional-grade properties that qualify for 1031 exchanges.

Consider a DST if:

• You're burned out on LA tenant management — No more RSO restrictions, JCO eviction nightmares, or rent control compliance
• You can't find suitable replacement property in 45 days — DSTs can close in 3–5 business days
• You want passive income without operational headaches — Professional management handles everything
• You're 1031'ing out of a property requiring major capital improvements — Avoid six-figure rehab projects
• You're nearing retirement — Shift from active management to mailbox money

DSTs allow you to preserve 1031 exchange tax benefits while eliminating landlord responsibilities entirely.

Common 1031 Exchange Scenarios for LA Investors

Scenario 1: Exchanging Out of an RSO Property

If you're selling a rent-controlled property in LA, your replacement property does NOT need to be RSO. Many investors exchange out of restricted LA properties into cash-flowing assets in Long Beach, Pasadena, or unincorporated areas without rent control.

Scenario 2: Consolidating Multiple Properties

You can sell 3 separate single-family rentals and consolidate into one apartment building. This is called a "consolidation exchange" and simplifies management while preserving tax deferral.

Scenario 3: Portfolio Diversification Exchange

Sell one $2M apartment building and exchange into four $500K properties across different LA submarkets. Geographic diversification while maintaining 1031 benefits.

Scenario 4: The "Hotel California" Exchange

Own property in California but want to invest elsewhere? You can 1031 from CA property into out-of-state property (though you cannot exchange US property for foreign property). Some investors exchange LA properties into Texas, Arizona, or Nevada for better cash flow.

SECTION 7 — What I Bring to LA Investors

Most real estate agents don't understand LA's unique 1031 challenges — and many CPAs who don't specialize in real estate exchanges may not account for RSO restrictions, JCO eviction complexity, or how rent control affects property valuation timing.

That's where working with a broker who specializes in LA investment property becomes essential.

What you get when working with me:

• Deep LA rent control and eviction law expertise
• Ability to evaluate cash flow on your Schedule E
• Free Exchange Analysis Spreadsheet projecting tax consequences
• Pre-listing exchange strategy sessions
• Qualified Intermediary coordination
• Contract leverage (timeline extensions built into offers)
• Early upleg identification before you even list
• DST options for investors seeking passive income
• Problem-solving when timelines get tight and deals get complicated

This is where clients get the biggest value — strategic planning that prevents problems rather than reacting to crises.

Recent Client Result

"Justin helped me exchange out of a rent-controlled 4-unit in Echo Park ($1.95M sale) into a 12-unit in Long Beach with zero rent control. My monthly cash flow went from $2,400/month to $11,200/month—and I deferred $340K in taxes."

— Michael T., Real Estate Investor, Los Angeles

Property details verified through recorded deed transfer. Tax deferral calculation based on client's CPA analysis. Individual results vary.

Need Help Navigating Your 1031 Exchange in LA?
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Frequently Asked Questions

Can I live in the replacement property after a 1031 exchange?

Eventually, yes — but only after satisfying IRS investment intent requirements. Most tax professionals recommend holding the replacement property as a bona fide rental for at least 1–2 years before converting to personal use. The IRS evaluates investment intent based on holding period, rental activity, depreciation deductions, and documentation. Converting immediately after the exchange will likely trigger IRS scrutiny and potential tax liability. Consult your CPA or tax attorney before making any conversion decisions.

Can I identify properties after Day 45 in a 1031 exchange?

No. Your identification list becomes permanently locked at midnight on Day 45. You cannot add properties, remove properties, or modify your list after this deadline under any circumstances. This is why pre-planning and early property identification are critical to 1031 exchange success.

What if my lender delays closing past Day 180?

IRS rules do not allow extensions for any reason, including lender delays. Closing must occur by Day 180 or the exchange fails and becomes fully taxable. This is why experienced 1031 brokers build buffer time into timelines and work with lenders who understand exchange deadlines.

Can I pull cash out during a 1031 exchange?

Yes — but it requires proper structuring and will trigger partial taxable gain. Many LA investors pull $50K–$100K in cash out of exchanges while still deferring the majority of their tax liability. This is called "boot" in IRS terminology. Your Qualified Intermediary and CPA must coordinate this carefully. Do not attempt this without professional guidance.

Can I identify more than 3 properties in a 1031 exchange?

Yes, under the 200% Rule (total value cannot exceed 200% of your relinquished property) or the 95% Rule (you must close on 95% of total identified value). Most investors use the simpler Three-Property Rule to avoid calculation errors and closing obligations.