1031 Exchanges in Divorce: What to Know

As home values have risen, selling real property can trigger significant capital gains exposure. In some situations, a 1031 exchange may allow those gains to be deferred by reinvesting proceeds into another qualifying property. While often discussed as a straightforward solution, 1031 exchanges are highly technical and easy to mishandle — especially in divorce.

To qualify, the exchange must involve investment property only. Primary residences and vacation homes are excluded, with very limited exceptions. The replacement property must also be held for investment purposes and be considered “like-kind” under IRS guidelines.

Strict timelines apply:

• A replacement property must be identified in writing within 45 days of selling the relinquished property

• The replacement purchase must close within 180 days

• Proceeds from the sale cannot be accessed by the owner and must be held by a qualified intermediary

Divorce adds another layer of complexity. Generally, the replacement property must be acquired in the same taxable ownership structure as the original property. For example, if spouses jointly owned a rental property, they typically must acquire the replacement property together. While IRS Code Section 1041 allows for tax-free transfers between spouses, this approach requires careful coordination with an experienced tax professional.

Additional considerations arise when a spouse plans to convert a former rental property into a primary residence. Properties acquired through a 1031 exchange have ongoing compliance requirements, and changing the property’s use can affect future tax treatment when sold.

Because 1031 exchanges are procedural and unforgiving, early planning and coordination with qualified tax and real estate professionals is essential — particularly in divorce matters. The IRS Fact Sheet on 1031 Exchanges offers a helpful starting point for those exploring this strategy.