1031 Exchange Guide for Washington Investors

You bought a rental property in Renton five years ago for $500,000. It's now worth $700,000, and you want to sell and buy something bigger. But selling means paying capital gains tax on that $200,000 profit—potentially $50,000 or more in federal and state taxes combined.

There's a way to defer those taxes indefinitely: a 1031 exchange. Named after Section 1031 of the Internal Revenue Code, this strategy lets you sell an investment property and buy another without paying capital gains tax, as long as you follow strict rules.

In this article, you'll learn:

How 1031 exchanges work and who can use them
The strict timelines you must follow (45 days to identify, 180 days to close)
What properties qualify and what doesn't
How to find and work with a qualified intermediary
Common mistakes that disqualify exchanges
Real examples from Seattle-area investors
Washington's 2025 capital gains tax changes and how they affect you

This article is for you if: You own investment property and are considering selling, want to understand tax-deferral strategies, or are building a real estate portfolio.

What Is a 1031 Exchange?
Tax Benefits and Washington State Considerations
Who Can Use a 1031 Exchange?
The Strict Timeline Rules
How a 1031 Exchange Works: Step by Step
Financial Requirements: Equal or Up
What Is "Boot" and Why It Matters
Common 1031 Exchange Mistakes
Special Situations
Real Seattle-Area Examples
Tax Implications and Basis
Costs of a 1031 Exchange
Alternatives to 1031 Exchanges
Summary: Key Takeaways
Next Steps
Additional Resources

What Is a 1031 Exchange?

A 1031 exchange (also called a like-kind exchange) allows you to sell an investment property and buy another investment property while deferring capital gains taxes.

The basic concept:

You sell Property A (relinquished property)
You buy Property B (replacement property)
You don't pay capital gains tax on the sale of Property A
Your tax basis carries over to Property B

Important: This is tax deferral, not tax elimination. You'll eventually pay taxes when you sell the final property, unless you:

Keep exchanging into new properties indefinitely
Hold until death (heirs get stepped-up basis)
Convert to primary residence (different rules apply)

Tax Benefits and Washington State Considerations

The primary benefit of a 1031 exchange is deferring both federal and Washington state capital gains taxes.

Federal taxes deferred:

Long-term capital gains: 15-20% depending on income
Depreciation recapture: 25% on depreciation taken
Net Investment Income Tax: 3.8% for high earners

Washington state taxes deferred (2025 rates):

7% on capital gains up to $1 million (over $250,000 standard deduction)
9.9% on capital gains exceeding $1 million
Applies to both residents and non-residents with Washington-source income

Example: Selling a property with $200,000 in capital gains

Without 1031 exchange:

Federal capital gains (20%): $40,000
Washington state tax (7%): $14,000
Total taxes: $54,000
Net proceeds to reinvest: $146,000

With 1031 exchange:

Taxes deferred: $54,000
Full proceeds to reinvest: $200,000
Additional investment capital: $54,000

By deferring $54,000 in taxes, you preserve more capital for continued growth and compound returns.

Who Can Use a 1031 Exchange?

Qualifying properties:

Rental properties (single-family, multi-family, apartments)
Commercial real estate (office, retail, industrial)
Land held for investment
Vacation rentals (with restrictions)

Non-qualifying properties:

Primary residences (use Section 121 exclusion instead)
Fix-and-flip properties (considered inventory, not investment)
Properties held primarily for sale
Vacation homes used primarily for personal use

The Strict Timeline Rules

1031 exchanges have two critical deadlines. Miss either one, and the entire exchange fails.

45-Day Identification Period

From the day you close on your relinquished property, you have 45 calendar days to identify potential replacement properties.

Identification rules (choose one):

Three-Property Rule (most common):

Identify up to 3 properties of any value
You must close on at least one of them

200% Rule:

Identify any number of properties
Total value cannot exceed 200% of relinquished property value

95% Rule:

Identify any number of properties of any value
Must close on properties worth at least 95% of total identified value

Example: You sell a property for $700,000

Three-Property Rule:

Identify Property A ($800,000), Property B ($750,000), Property C ($900,000)
Must close on at least one

200% Rule:

Can identify multiple properties
Total value cannot exceed $1,400,000 (200% of $700,000)

95% Rule:

Identify properties totaling $2,000,000
Must close on properties worth at least $1,900,000 (95% of $2,000,000)

180-Day Exchange Period

You have 180 calendar days from closing on your relinquished property to close on your replacement property.

Important: The 180 days runs concurrently with the 45 days, not after. So you really have:

Days 1-45: Identify replacement properties
Days 46-180: Close on replacement property

Example timeline:

January 15: Close on sale of Renton property
March 1 (45 days): Deadline to identify replacement properties
July 14 (180 days): Deadline to close on replacement property

No extensions: These deadlines are absolute. Weekends, holidays, and natural disasters don't extend them (with rare exceptions for federally declared disasters).

How a 1031 Exchange Works: Step by Step

Step 1: Decide to Do a 1031 Exchange (Before Listing)

You must intend to do a 1031 exchange before you sell. You can't decide after closing.

Action items:

Consult with CPA about tax implications
Find a qualified intermediary (QI)
Understand your timeline and budget
Start researching replacement properties

Step 2: Hire a Qualified Intermediary

You cannot touch the sale proceeds. A qualified intermediary (QI) holds the money between transactions.

What a QI does:

Holds sale proceeds in escrow
Prepares exchange documents
Coordinates with title companies
Ensures IRS compliance
Releases funds for replacement property purchase

Seattle-area qualified intermediaries:

Investment Property Exchange Services (IPX1031)
Asset Preservation, Inc.
Accruit (formerly 1031 Corporation)
Typical cost: $800-1,500 per exchange

Important: The QI cannot be:

Your real estate agent
Your attorney
Your CPA
Your employee
Anyone who has worked for you in the past 2 years

Step 3: List and Sell Your Property

List your property normally, but include 1031 exchange language in the purchase and sale agreement.

Key contract provisions:

Buyer acknowledges seller is doing a 1031 exchange
Buyer agrees to cooperate (doesn't cost them anything)
Assignment clause allowing QI to step in

At closing:

You assign your rights to the QI
Sale proceeds go directly to QI (you never touch them)
QI holds funds in escrow account

Critical: If you receive any proceeds, the exchange is disqualified. Everything must go through the QI.

Step 4: Identify Replacement Properties (Within 45 Days)

Start looking immediately. 45 days goes fast, especially in competitive markets.

Identification requirements:

Must be in writing
Must be signed by you
Must be delivered to QI before midnight on day 45
Must include property address or legal description

Pro tip: Identify 3 properties even if you're confident about one. Deals fall through, and you can't add properties after day 45.

Example identification letter:

I hereby identify the following properties as potential replacement properties:

1. 123 Main Street, Bellevue, WA 98004 (Parcel #123456789)
2. 456 Oak Avenue, Redmond, WA 98052 (Parcel #987654321)
3. 789 Pine Road, Kirkland, WA 98033 (Parcel #456789123)

Signed: [Your Name]
Date: [Within 45 days of relinquished property closing]

Step 5: Purchase Replacement Property (Within 180 Days)

Make an offer on one of your identified properties.

Purchase contract requirements:

Must be one of the properties you identified
QI is the buyer (you're assigned as buyer at closing)
Purchase price should equal or exceed sale price
Debt on new property should equal or exceed debt on old property

At closing:

QI uses escrowed funds for down payment
You arrange financing for the balance
Title transfers from QI to you
Exchange is complete

Step 6: Report to IRS

File Form 8824 (Like-Kind Exchanges) with your tax return for the year of the exchange.

Form 8824 includes:

Description of properties exchanged
Dates of transfer
Relationship to other party (none in most cases)
Realized gain and recognized gain
Basis of replacement property

Important: Even though you're deferring taxes, you must still report the exchange to the IRS.

Financial Requirements: Equal or Up

To defer 100% of capital gains, you must follow two rules:

Rule 1: Equal or Greater Value

The replacement property must be equal or greater in value than the relinquished property.

Example:

Sell property for $700,000
Buy property for $800,000
✅ Full deferral

Example:

Sell property for $700,000
Buy property for $650,000
❌ $50,000 is taxable "boot"

Rule 2: Equal or Greater Debt

The debt on your replacement property must be equal or greater than the debt on your relinquished property.

Example:

Relinquished property: $700,000 value, $300,000 mortgage
Replacement property: $800,000 value, $350,000 mortgage
✅ Full deferral

Example:

Relinquished property: $700,000 value, $300,000 mortgage
Replacement property: $800,000 value, $200,000 mortgage
❌ $100,000 debt reduction is taxable

Solution: Add cash to make up the difference. If you reduce debt by $100,000, add $100,000 cash to the purchase.

What Is "Boot" and Why It Matters

"Boot" is any value you receive that isn't like-kind property. Boot is taxable.

Types of boot:

Cash boot:

Any cash you receive from the sale
Debt reduction (paying off more debt than you take on)

Mortgage boot:

Reducing debt without replacing it with equal debt

Personal property boot:

Appliances, furniture, equipment included in sale

Example of boot:

Sell property for $700,000 with $300,000 mortgage (net equity: $400,000)
Buy property for $750,000 with $250,000 mortgage (net equity: $500,000)
You added $100,000 cash, but reduced debt by $50,000
$50,000 debt reduction = $50,000 taxable boot

How to avoid boot:

Buy property of equal or greater value
Take on equal or greater debt
Don't receive any cash
Use all proceeds plus additional cash if needed

Common 1031 Exchange Mistakes

Mistake 1: Missing the 45-Day Deadline

What happens: The entire exchange fails. You owe capital gains tax on the full amount.

How to avoid:

Start looking for replacement properties before you list
Have backup properties identified
Use a real estate agent familiar with 1031 exchanges
Set a reminder for day 40 (give yourself buffer)

Mistake 2: Touching the Money

What happens: If you receive proceeds, even temporarily, the exchange is disqualified.

How to avoid:

Hire QI before closing on relinquished property
Ensure all documents route proceeds to QI
Never have proceeds deposited to your account
Don't use your attorney or CPA as QI (disqualified persons)

Mistake 3: Buying Personal Use Property

What happens: Personal use property doesn't qualify. Exchange fails.

How to avoid:

Replacement property must be held for investment or business use
If buying vacation property, must rent it out (see vacation home rules below)
Document investment intent (rental ads, property management agreement)

Mistake 4: Identifying Properties Incorrectly

What happens: If identification is invalid, you can't close on those properties.

How to avoid:

Use complete legal descriptions or addresses
Submit in writing to QI
Get confirmation from QI that identification was received
Don't rely on verbal identification

Mistake 5: Not Planning for Financing

What happens: Can't close within 180 days because financing falls through.

How to avoid:

Get pre-approved before selling relinquished property
Understand that QI holds your down payment (can't access it early)
Have additional funds available if needed
Work with lender experienced in 1031 exchanges

Mistake 6: Buying Property Not on Identification List

What happens: Exchange fails. You owe taxes on the gain.

How to avoid:

Only close on properties you identified within 45 days
If deal falls through, choose from other identified properties
Can't add new properties after day 45

Special Situations

Vacation Homes and 1031 Exchanges

Vacation homes can qualify, but there are strict rules (Revenue Procedure 2008-16):

Requirements:

Must rent property at fair market rate for at least 14 days per year
Personal use limited to 14 days or 10% of rental days (whichever is greater)
Must hold for at least 2 years after exchange
Must rent for at least 2 years after exchange

Example:

Rent property for 100 days per year
Personal use limited to 14 days (greater than 10% of 100 days)
Must continue this pattern for 2 years

Important: IRS scrutinizes vacation home exchanges closely. Document everything.

Reverse 1031 Exchanges

What if you find your replacement property before selling your relinquished property?

Reverse exchange process:

QI purchases replacement property (you can't own both simultaneously)
You have 45 days to identify relinquished property
You have 180 days to sell relinquished property
QI transfers replacement property to you

Challenges:

More complex and expensive ($3,000-5,000 in QI fees)
QI must arrange financing or you must provide cash
Not all QIs offer reverse exchanges

Improvement/Construction Exchanges

You can use exchange funds to improve the replacement property, but it's complicated.

Requirements:

Improvements must be completed within 180 days
QI holds title during construction
You can't take title until improvements are done
Must identify both property and improvements within 45 days

Example:

Sell property for $700,000
Buy property for $600,000
Use $100,000 for improvements
All improvements must be done within 180 days

Delaware Statutory Trusts (DSTs)

Can't find a suitable replacement property? Consider a DST.

What is a DST:

Fractional ownership in institutional-grade property
Professionally managed
Minimum investment typically $100,000
Qualifies for 1031 exchange

Pros:

No property management responsibilities
Diversification (own piece of multiple properties)
Can close quickly (helpful near 180-day deadline)

Cons:

Illiquid (typically 5-10 year hold)
Fees reduce returns
No control over property decisions
Securities offering (requires accredited investor status)

Real Seattle-Area Examples

Example 1: Successful Exchange

Situation:

Owned rental house in Rainier Valley for 8 years
Purchase price: $450,000
Sale price: $650,000
Mortgage: $200,000
Net proceeds: $450,000
Capital gain: $200,000

Exchange:

Hired QI before listing ($1,200 fee)
Sold property on March 1
Identified 3 duplexes in Renton by April 15 (day 45)
Closed on $750,000 duplex on June 15 (day 106)
New mortgage: $300,000
Added $150,000 cash to purchase

Result:

Deferred $40,000 in federal capital gains tax
Deferred $14,000 in Washington state tax
Total tax savings: $54,000
Upgraded to higher-income property
Increased depreciation deductions

Example 2: Failed Exchange (Missed Deadline)

Situation:

Sold rental condo in Bellevue for $550,000
Identified 3 properties within 45 days
First choice fell through (inspection issues)
Second choice seller backed out
Third choice appraisal came in low, couldn't get financing

Result:

Couldn't close on any property within 180 days
Exchange failed
Owed $27,500 in federal capital gains tax
Owed $10,500 in Washington state tax
Total taxes: $38,000
Lesson: Identify more than 3 properties if possible, or include backup financing options

Example 3: Partial Exchange (Boot)

Situation:

Sold rental property for $600,000 (no mortgage)
Bought replacement for $550,000 with $200,000 mortgage
Received $50,000 cash back

Result:

$50,000 cash = taxable boot
Paid capital gains on $50,000
Deferred taxes on remaining gain
Lesson: Should have bought property worth at least $600,000 to avoid boot

Tax Implications and Basis

How Basis Carries Forward

Your tax basis in the replacement property equals:

Basis in relinquished property
Plus: Cash added to exchange
Plus: Boot paid
Minus: Boot received

Example:

Relinquished property basis: $450,000
Sale price: $650,000
Realized gain: $200,000
Replacement property cost: $750,000
Cash added: $100,000

New basis calculation:

Old basis: $450,000
Plus cash added: $100,000
New basis: $550,000

Important: Your basis is $550,000, not the $750,000 you paid. The $200,000 deferred gain reduces your basis.

Depreciation Recapture

When you eventually sell (without doing another 1031), you'll owe:

Capital gains tax on appreciation
Depreciation recapture tax (25% federal rate)
Washington state capital gains tax (7% or 9.9% depending on amount)

Example:

Original purchase: $450,000
Depreciation taken: $100,000
Adjusted basis: $350,000
Sale price: $650,000
Capital gain: $300,000

Tax owed:

Depreciation recapture: $100,000 × 25% = $25,000
Long-term capital gains: $200,000 × 20% = $40,000
Washington state tax: $200,000 × 7% = $14,000
Total: $79,000

1031 exchange defers all of these until you sell the final property.

Estate Planning Strategy

Many investors do 1031 exchanges indefinitely and hold until death.

Why this works:

Heirs receive stepped-up basis (property value at death)
Deferred capital gains disappear
Heirs can sell immediately with no tax

Example:

You buy property for $450,000
Do 3 exchanges over 30 years
Final property worth $2,000,000
You die, heirs inherit
Heirs' basis: $2,000,000 (stepped up)
Deferred gains: $0 (forgiven)

Important: Estate tax may apply if total estate exceeds exemption ($13.61 million in 2024), but capital gains tax is eliminated.

Costs of a 1031 Exchange

Qualified intermediary fees:

Standard exchange: $800-1,500
Reverse exchange: $3,000-5,000
Improvement exchange: $4,000-8,000

Additional costs:

CPA consultation: $500-1,500
Attorney review (optional): $1,000-2,000
Extra title/escrow fees: $500-1,000

Total typical cost: $2,000-4,000

Is it worth it?

Example:

Capital gain: $200,000
Federal tax (20%): $40,000
Washington state tax (7%): $14,000
Total tax saved: $54,000
Exchange costs: $2,500
Net benefit: $51,500

Yes, usually worth it for gains over $50,000.

Alternatives to 1031 Exchanges

Installment Sale

Spread capital gains over multiple years by receiving payments over time.

Pros:

Simpler than 1031
No strict timelines
Can receive some cash

Cons:

Still pay taxes (just spread out)
Risk if buyer defaults
Interest income is taxable

Opportunity Zone Investment

Invest capital gains in designated Opportunity Zones for tax benefits.

Pros:

Can defer gains until 2026
Potential for tax-free appreciation after 10 years

Cons:

Limited to specific geographic areas
Must invest in Opportunity Zone fund
Complex rules

Convert to Primary Residence

Live in the property for 2 of the last 5 years before selling.

Pros:

Exclude up to $250,000 gain ($500,000 married)
No exchange complexity

Cons:

Must actually live there for 2 years
Depreciation recapture still applies
Partial exclusion for rental years

Summary: Key Takeaways

1031 exchanges allow you to defer capital gains tax when selling investment property
You must identify replacement properties within 45 days and close within 180 days
A qualified intermediary must hold all proceeds (you cannot touch the money)
Replacement property must be equal or greater in value and debt
Any cash received or debt reduction creates taxable "boot"
Common mistakes include missing deadlines, touching proceeds, and buying personal-use property
Vacation homes can qualify with strict rental requirements
Costs typically $2,000-4,000 but save tens of thousands in taxes
Can exchange indefinitely and pass to heirs with stepped-up basis
Washington state capital gains tax: 7% up to $1M, 9.9% over $1M (2025 rates)

Next Steps

If you're considering a 1031 exchange:

Consult a CPA experienced in 1031 exchanges before listing your property
Interview qualified intermediaries and choose one before you sell
Start researching replacement properties before you list (don't wait for 45-day period)
Get pre-approved for financing on replacement property
Build a team: QI, CPA, real estate agent experienced in 1031s
Create a timeline with all critical dates marked
Have backup properties identified in case your first choice falls through

Related articles:

Rental Yield Basics - Understanding investment property returns
Property Type Comparison - Choosing the right investment property
Refinance Basics - Alternative strategies for accessing equity

Additional Resources

IRS Publication 544 - Sales and Other Dispositions of Assets
IRS Form 8824 - Like-Kind Exchanges
Federation of Exchange Accommodators - Find qualified intermediaries
IPX1031 - Seattle-area qualified intermediary
Asset Preservation, Inc. - National QI with Seattle presence
Washington Department of Revenue - State capital gains tax information

Disclaimer: This article provides general information only. 1031 exchanges involve complex tax law. Consult with a qualified CPA and tax attorney before proceeding with any exchange.