1031 Tax-Deferred
Exchanges.
The most powerful tax strategy in real estate is alive and well in 2026. Sell one investment property, buy another, and defer capital gains taxes at both the federal and Pennsylvania state level.
What is a 1031 Exchange?
A Section 1031 exchange (named after Section 1031 of the Internal Revenue Code) lets you sell an investment property and reinvest the proceeds into like-kind investment or business real estate while deferring capital gains tax and depreciation recapture.
Here is the headline news for 2026: Section 1031 remains fully intact for real estate. Congress debated limiting like-kind exchanges during the One Big Beautiful Bill Act (OBBBA), but the final law preserved Section 1031 unchanged for real property. There is no dollar cap, no phase-out, and no change to the rules that make the 1031 exchange the workhorse of real estate wealth building.
One important boundary: only real property qualifies. Personal property such as equipment, vehicles, and furnishings stopped qualifying in 2018, and that scope is unchanged in 2026. Nearly all real estate held for investment or business use does qualify.
"Like-kind" is broader than many investors expect. You can exchange an apartment building for a single-family rental, raw land for a duplex, or a commercial property for a residential rental. What matters is that both properties are held for investment or business use, not personal use.
Pennsylvania Now Defers State Tax Too
Since the 2023 tax year, Pennsylvania recognizes like-kind exchanges at the state level. House Bill 1342, signed on July 8, 2022 as Act 53 of 2022, took effect for tax years beginning after December 31, 2022, and Pennsylvania's state treatment now matches the federal rules.
That is a genuinely big deal for Lehigh Valley investors. A proper 1031 exchange in 2026 now defers both the federal capital gains tax and Pennsylvania state income tax on the gain, not just the federal piece. Instead of paying Pennsylvania's 3.07% personal income tax rate on the gain, the full sales proceeds keep working for you in your replacement property.
- Defer federal capital gains tax and depreciation recapture on the sale of investment real estate.
- Defer Pennsylvania state income tax on the same gain, because Pennsylvania now follows the federal like-kind rules for tax years beginning after December 31, 2022.
- Keep exchanges seamless across Northampton, Lehigh, and Carbon Counties, where one clean set of federal rules now applies at both levels of government.
How a 1031 Exchange Works: The Deadlines
1031 exchanges run on two strict deadlines that cannot be extended. Missing either one disqualifies the exchange, so precision matters. The clock starts on the actual closing date of the property you sell, not when you sign a contract or receive proceeds.
Day 0: Close on Your Relinquished Property
You close on the sale of your investment property. The proceeds must go directly to a qualified intermediary (QI), never to you personally. If you take constructive receipt of the funds, the exchange fails and the deferred taxes come due.
Days 1-45: Identify Replacement Property
Within 45 calendar days after closing, you must formally identify potential replacement properties in writing. You may identify up to three properties of any value, any number of properties as long as their combined value does not exceed 200% of the value of the property you sold, or, under the 95% rule, more properties as long as you acquire at least 95% of the total value you identified.
Days 46-180: Close on Replacement Property
You must close on and take title to the replacement property within 180 calendar days, or by your tax return due date including extensions if that date comes first. Watch year-end closings: an exchange completed in the fourth quarter can have an effectively shorter window because the return due date lands before the 180th day.
Neither deadline can be extended, and neither can be missed. The 45-day and 180-day clocks both run from the actual closing date of the relinquished property. Work with a qualified intermediary from day one so the structure is in place before you list.
Types of 1031 Exchanges
Forward Exchange (Standard)
The most common type. You sell your relinquished property first, then identify and purchase the replacement property within the 45-day and 180-day windows while the proceeds sit with a qualified intermediary.
Reverse Exchange
You purchase the replacement property before selling your relinquished property. An Exchange Accommodation Titleholder (EAT) holds one of the properties during the exchange. More complex and costly, but valuable in competitive markets where you cannot wait to buy.
Improvement (Build-to-Suit) Exchange
Exchange proceeds are used to make capital improvements on the replacement property before you take title. This lets you use your tax-deferred dollars to upgrade the new property, essentially converting deferred taxes into property improvements.
Key Rules
Same Taxpayer
The person or entity selling the property must be the same entity purchasing the replacement property.
Real Property Only
Only real property qualifies in 2026. Personal property such as equipment and vehicles has not qualified since 2018.
Like-Kind Investment or Business Use
Both properties must be held for investment or business use, not personal use. Nearly all real estate held for those purposes qualifies.
Qualified Intermediary
A neutral qualified intermediary must hold the exchange funds. Constructive receipt of the proceeds by the investor fails the exchange.
Equal or Greater Value
To defer all taxes, the replacement property must be equal to or greater in value than the property sold.
No Boot
Any cash received (called "boot") is taxable. To fully defer taxes, reinvest all proceeds.
The Power of Sequential 1031 Exchanges
The true wealth-building power comes from doing 1031 exchanges repeatedly over your investing career. You buy Property A for $200,000, exchange it for Property B worth $350,000, exchange that for Property D worth $500,000, and so on, never paying capital gains taxes along the way, at either the federal or the Pennsylvania state level.
When you eventually pass properties to your heirs, they receive a step-up in cost basis, effectively eliminating all deferred capital gains taxes. This is how generational real estate wealth is built.
Exchanging Into a DST
Delaware Statutory Trusts (DSTs) remain one of the most popular ways to complete a 1031 exchange in 2026. By exchanging into a DST, you acquire a fractional, passive ownership interest in institutional-quality real estate as your replacement property, deferring tax while a professional sponsor handles the operations.
DST interests have qualified as like-kind real property since IRS Revenue Ruling 2004-86, and Pennsylvania's state-level recognition means the deferred gain is not taxed by the state either. This is a particularly good fit for investors ready to trade landlord duties for passive income. Read the full Delaware Statutory Trusts guide for details.
Frequently Asked Questions
Are 1031 exchanges still allowed in 2026?
Yes. Section 1031 remains fully intact for real estate after the One Big Beautiful Bill Act (OBBBA). Despite proposals to cap or repeal the provision, the final 2025 law preserved it unchanged for real property. Only real property qualifies; personal property does not.
Does Pennsylvania recognize 1031 exchanges at the state level?
Yes, since the 2023 tax year. Act 53 of 2022 (House Bill 1342, signed July 8, 2022) aligned Pennsylvania with the federal rules for tax years beginning after December 31, 2022, so a gain deferred federally is also deferred for Pennsylvania state income tax. That means Lehigh Valley investors defer both federal and state tax on a proper exchange.
Can I do a 1031 exchange on my primary residence?
No. 1031 exchanges only apply to investment or business-use properties. However, there is a separate exclusion (Section 121) that allows you to exclude up to $250,000 ($500,000 married) in capital gains on a primary residence. You cannot combine both strategies on the same property.
What happens if I miss the 45-day or 180-day deadline?
The exchange fails. The deadlines cannot be extended, and the IRS treats an uncompleted exchange as a taxable sale. That is why it pays to have a qualified intermediary and an experienced real estate professional in place before you list your property.
How much money can I save with a 1031 exchange?
The savings depend on your capital gains. On a $100,000 gain, a sale without an exchange could cost roughly $20,000 to $28,000 in federal tax (15-20% federal capital gains plus the 3.8% Net Investment Income Tax) and Pennsylvania's 3.07% state rate. A proper exchange defers the tax at both levels, so the full amount stays invested in your replacement property. Confirm the exact math for your situation with a tax advisor.
Executing a 1031 exchange requires precision and expertise, and exchange rules are complex. Tim Tepes guides investors through every step of the process, but confirm the details of your specific transaction with a qualified tax advisor or CPA before you sell. For official IRS guidance, see IRS Publication 544 and the IRS Like-Kind Exchanges page.