Understanding Arizona 1031 exchanges

What is a 1031 exchange?

A 1031 exchange, also known as a “like-kind exchange,” is a federal tax deferral strategy that lets an investor sell one investment (or business-use) real property and reinvest the proceeds into another qualifying real property without paying federal income tax on the gain at the time of sale. It’s governed by Section 1031 of the U.S. Internal Revenue Code and administered by the IRS.
 

What is “real property”?

Real property is land and the permanent things attached to it, like a building, a rental home, or other improvements that are part of the land.

Section 1031 only applies to exchanges of real property, not personal property like equipment, furniture, or vehicles.
 

Key requirements for a 1031 exchange

1. The property must qualify

   Both the property being sold and the one being purchased must be held for business or investment purposes. A primary residence does not fit within the rules.
    

2. A qualified intermediary must hold the funds

   The investor cannot receive or control the sale proceeds. A qualified intermediary (QI) is an independent third party who holds the money between the sale and the purchase. If the investor touches the funds, the exchange is usually invalid.
    

3. The 45-day deadline to identify replacement property

   Within 45 days after the sale closes, the investor must formally identify potential properties that they may buy to the qualified intermediary. The list must be in writing and follow IRS identification rules. Investors are commonly allowed to identify up to three possible replacement properties under the standard identification rule.
    

4. The 180-day timeline to complete the purchase

   The replacement property must be purchased within 180 days of the sale of the original property, or by the due date of the investor’s tax return for that year (including extensions), whichever comes first. The 45-day and 180-day windows run at the same time, not one after the other.
    

5. Matching the replacement property to the identification list

   The investor must purchase a property that appeared on their written identification list. Properties may be changed or added during the 45-day identification period, but changing or adding properties after the 45-day deadline is not allowed.
    

6. Documentation needed for a valid exchange

   The exchange agreement, identification notices, closing statements, purchase and sale agreement, certificate of citizenship, and intermediary documents need to fit IRS rules. An appraisal may also be necessary to establish the fair market value of both the relinquished property and the replacement property. A tax professional usually helps confirm that the paperwork supports the exchange.

Property types

Most 1031 exchanges involve investment real estate such as:

• Single-family rentals
   
• Small multifamily properties
   
• Larger apartment buildings
   
• Retail/office/industrial property
   
• Raw land held for investment
   
• Certain mineral interests
   

Common examples that are typically not eligible include a primary residence, property you’re holding primarily for resale (a “flip”), and partnership interests. Your tax advisor can help confirm how your use and intent affect eligibility.
 

The 200% rule

The 200% rule can allow an investor to list more than three possible replacement properties as long as the combined value of those properties is no more than twice the value of the property that was sold. This rule is helpful when you want extra options or are looking at several smaller properties, as long as the total value stays within the allowed limit.
 

The role of a qualified intermediary

For most 1031 exchanges, a qualified intermediary is the independent “middle person” who helps structure the exchange so the sale proceeds don’t go into your control. The QI receives the funds from the sale, holds them, and then uses them to buy the replacement property on your behalf.
 

Who cannot be a QI?

Your QI cannot be anyone who served as your employee, attorney, accountant, investment banker/broker, or real estate agent/broker at any time in the two years before you transfer your first relinquished property, except for limited routine title, escrow, or banking-type services.

This matters because a 1031 exchange generally fails if you or someone acting as your agent can access the money before the replacement purchase closes.
 

Other IRS safe harbors besides a qualified intermediary

While a qualified intermediary is the most common setup, IRS rules also recognize other “safe harbor” arrangements that can help prevent you from being treated as having received the sale proceeds. Two common alternatives are a “qualified escrow account” or a “qualified trust,” as long as the agreement strictly limits your ability to access the funds before the exchange is completed.

These arrangements are functionally similar to using a QI because they are designed to prevent the investor from having actual or constructive receipt of the funds. However, many standard escrow or trust agreements do not meet the strict requirements for these safe harbors, so they need to be carefully structured and reviewed.
 

Lower-value property exchanges (“boot”)

If the replacement property costs less than the one you sold or you keep part of the sale proceeds, the leftover amount may be taxable. This is often called the “boot.” Boot can also come from credits or non-real-estate items on the closing statement. Because small details can change the tax result, most investors have their qualified intermediary and CPA review the figures before the exchange closes.
 

Arizona’s state income tax rate and why 1031 still matters

Arizona had a flat 2.5% individual income tax rate as of 2025. Unlike other states, Arizona fully conforms to Section 1031. Even though that rate is relatively low compared to many states, a 1031 exchange can still be powerful because it:

• Defers federal capital gains tax, and
   
• Typically defers the gain for Arizona too because Arizona starts with federal adjusted gross income (AGI).

If you later sell without another 1031 exchange, the deferred gain is generally recognized and taxed at both the federal and state levels.
 

Reverse exchanges when you need to buy first

A reverse 1031 exchange is used when you need to buy the replacement property before you can sell your current one. Because you generally can’t take title to the new property first under standard 1031 rules, the process uses a temporary “parking” arrangement. A simple way to understand it is through the core steps:

1. You find the replacement property first. You want to move quickly, but you have not yet sold your current property.
    
2. A parking entity takes temporary title. Your exchange team, working with your qualified intermediary, arranges for the new property to be held by an Exchange Accommodation Titleholder (EAT) instead of you.
    
3. You sell your current property. Once the sale closes, the proceeds move through the qualified intermediary, just like a standard exchange.
    
4. The parked property is transferred to you. After your sale closes, the replacement property moves from the parking entity to you, completing the exchange.
    
5. Everything must fit within the 45/180-day safe-harbor windows. In a reverse exchange, unlike a traditional exchange, the 45-day rule generally applies to identifying the property being relinquished, and the entire transaction must be completed within 180 days. Timing is strict, so early coordination with your tax advisor and exchange professionals is important.

Reverse exchanges can help you secure a great property in a competitive market, but they require more planning and are usually more expensive than a standard 1031 exchange.
 

About FirstService Residential

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With over 45 years of experience across the state, we help HOAs, condo associations, high-rises, and master-planned communities operate smoothly and meet their goals with confidence. To learn how we can support your association, contact our Arizona team today.

This information is provided for general informational purposes only and is not intended to constitute, and should not be relied upon as, legal, regulatory, financial, or operational advice, or as a representation or guarantee of any specific services, capabilities, or outcomes. Property management needs, regulatory requirements, market conditions, and available services vary by jurisdiction, property type, and community. FirstService Residential provides services through locally based affiliates and associates, and services and results may vary by community, region, contractual terms, and applicable law.