Can You Use a 1031 Exchange to Buy a REIT Instead of Real Property
A 1031 exchange does not work with REITs, even though both involve real estate investments
No. The IRS does not permit a 1031 exchange into a REIT. A 1031 exchange lets you sell one investment property and buy another without paying capital gains tax on the profit — but only if you buy real property you will hold directly. A REIT is a security, not real property. When you own REIT shares, you own a fractional stake in a company that owns property; you do not own the property itself. The IRS treats these as fundamentally different things for tax purposes.
This matters because many investors assume that since REITs hold real estate, they should may have access to. They do not. The IRS Section 1031 rules are specific: you must exchange real property for real property. Shares in any company — including a real estate company — do not count, no matter what that company owns.
Key Takeaways
- A 1031 exchange requires you to buy real property you hold directly, not securities or shares in any company.
- REITs are securities, so selling a REIT and buying another REIT does not may have access to for 1031 treatment.
- Selling an investment property and buying REIT shares does not may have access to either — you must buy real property instead.
- If you sell an investment property, you can defer taxes by buying rental real estate, a commercial building, or raw land directly.
- Selling a REIT triggers capital gains tax on your profit, with no deferral option available.
Why REITs do not may have access to for 1031 exchanges
The 1031 rule exists to encourage long-term real estate investment by deferring taxes when you reinvest your proceeds. The IRS defines the may be able to access property narrowly: real property held for investment or business use. That means land, buildings, rental homes, commercial space — things you own and control directly.
A REIT share is a claim on a company's earnings and assets, not a direct ownership stake in real estate. You cannot walk onto the property, make decisions about it, or control how it is managed. The company does. From the IRS perspective, this difference is decisive. You are trading a security for a security, not real property for real property.
This rule applies even if the REIT holds the exact same building you sold. Even if you sold an apartment complex and bought shares in a REIT that owns an identical apartment complex in the same city, the exchange does not may have access to. The form of ownership — direct versus indirect — is what matters.
What happens when you sell a REIT
When you sell REIT shares at a profit, you owe capital gains tax on the difference between what you paid and what you sold it for. The tax rate depends on how long you held the shares. If you held them for more than one year, you pay long-term capital gains tax, which is lower than ordinary income tax rates. If you held them for one year or less, you pay short-term rates, which match your regular income tax bracket.
Unlike a 1031 exchange, there is no way to defer this tax. You cannot reinvest the proceeds into another REIT or into real property and avoid the tax bill. You pay it in the year you sell, regardless of what you do with the money afterward.
Some investors hold REITs specifically because they do not want to manage property directly. If you are in that group and you have a large gain, the tax bill is a real cost to consider before selling.
What you can do with a 1031 exchange instead
If you own investment real property — a rental house, an apartment building, commercial space, or raw land — and you want to sell it, a 1031 exchange lets you reinvest the proceeds tax-free. You have 45 days to identify a replacement property and 180 days to close on it. The replacement must be real property held for investment or business use.
This includes a wide range of options: another rental home, a commercial building, a strip mall, farmland, a parking lot, or even a fractional ownership stake in real property (though the rules around fractional ownership are complex). You can trade up to a more expensive property, trade down to a less expensive one, or trade into a completely different type of real estate.
Many investors use 1031 exchanges to consolidate multiple small properties into one larger one, or to move from residential to commercial real estate, or to relocate to a different market. The tax deferral can be substantial, especially if you have held the property for many years and it has appreciated significantly.
The difference between owning property and owning a REIT
Direct real estate ownership and REIT ownership serve different investor needs, and the tax treatment reflects that difference. When you own rental property directly, you control the asset, make decisions about maintenance and tenants, and can deduct expenses like repairs, property taxes, and mortgage interest. You also have the option to defer taxes through a 1031 exchange when you sell.
When you own a REIT, you have no control over the property or the company's decisions. You receive dividends from the company's earnings, and you can sell your shares whenever you want. You pay capital gains tax when you sell at a profit, with no deferral option. But you also avoid the work and liability of being a landlord.
Neither approach is better or worse — they suit different situations. But they are taxed differently, and the 1031 rules reflect that. If you want the tax deferral benefit, you need to own real property directly.
Strategies if you want to move from property to REITs
If you own investment property and want to shift toward REIT ownership without paying a large tax bill immediately, you have a few options. The most straightforward is to use a 1031 exchange to buy another piece of real property, then hold it for a few years while you plan your next move. This defers the tax and gives you time to think.
Another approach is to sell the property in a year when your other income is lower, so the capital gains tax falls into a lower bracket. This does not eliminate the tax, but it reduces it. You could also donate the property to a charity and take a charitable deduction, though this requires the property to may have access to and you to itemize deductions.
Some investors simply accept the tax bill as a cost of rebalancing their portfolio. If you have held the property for many years, the long-term capital gains rate may be 15% or 20%, depending on your income. That is lower than ordinary income tax, and if the property no longer fits your investment goals, paying the tax to move into REITs may make sense.
Frequently Asked Questions
Can I do a 1031 exchange from one REIT to another REIT?
No. Both are securities, so the exchange does not may have access to. Selling one REIT and buying another triggers capital gains tax on your profit. There is no tax deferral available, even though both REITs hold real estate.
What if I own a REIT and want to buy real property — can I use 1031 treatment?
No. The property you are selling must be real property for the 1031 exchange to work. Selling a REIT share and buying a rental house does not may have access to. You will owe capital gains tax on the REIT sale.
Can I use a 1031 exchange to buy shares in a real estate company that is not a REIT?
No. The rule applies to all securities and company shares, regardless of what the company owns. You must buy real property — land or buildings — that you hold directly.
If I do a 1031 exchange into real property, can I later sell that property and buy a REIT?
Yes, but you will owe capital gains tax on the second sale. The 1031 exchange only defers tax on the first transaction. When you eventually sell the replacement property, you can do another 1031 exchange into more real property, or you can sell and pay the tax.
Are there any exceptions to the 1031 rule for real estate companies?
No. The IRS does not make exceptions for REITs or other real estate companies, even if they are publicly traded or widely held. The rule is based on the form of ownership, not the quality or type of the underlying asset.