A 1031 exchange does not allow you to buy a REIT with the proceeds

The 1031 exchange is a tax deferral tool that lets you sell investment real property and reinvest the proceeds in other real property without triggering a capital gains tax at the time of sale. A REIT (real estate investment trust) is a company that owns or finances real estate, and its shares trade like stock. The IRS does not treat REIT shares as real property for 1031 purposes, so you cannot use a 1031 exchange to buy them.

This is a hard rule, not a gray area. If you sell real property through a 1031 exchange and try to reinvest in a REIT, the IRS will treat the transaction as a taxable sale. You will owe capital gains tax on the profit from your original property sale in the year you complete the exchange.

The reason is structural: a 1031 exchange requires you to reinvest in like-kind property. For real estate, like-kind means real property held for investment or business use — a rental house, apartment building, commercial space, or raw land. A REIT share is a security, not real property. Owning a REIT share gives you exposure to real estate value, but it does not give you title to the underlying land or buildings.

Key Takeaways

  • REIT shares do not may have access to as like-kind property under 1031 exchange rules, even though REITs own real estate.
  • Using 1031 proceeds to buy REIT shares triggers capital gains tax on your original property sale in that tax year.
  • If you want to defer taxes, you must reinvest in direct real property ownership — land, buildings, or mortgages on real property.
  • Some investors use a 1031 exchange to buy a property, then later sell that property and buy REIT shares with the proceeds, but that second transaction is taxable.

What counts as like-kind property in a 1031 exchange

The IRS has a narrow definition of real property that qualifies for 1031 treatment. You can exchange into rental houses, apartment complexes, office buildings, retail space, industrial warehouses, farmland, and vacant land held for investment. You can also exchange into a mortgage or deed of trust secured by real property, or into a partnership interest if the partnership holds only real property.

What does not count: stocks (including REIT shares), bonds, notes, partnership interests in partnerships that hold other assets, business equipment, personal property, or cryptocurrency. The property you buy must be held for investment or business use, not for personal use. A vacation home you rent out part of the year can may have access to, but your primary residence cannot.

The exchange also has strict timing rules. You have 45 days from the sale of your original property to identify the replacement property in writing, and 180 days to close on it. If you miss either important date, the entire exchange fails and you owe tax on the gain.

Why REITs are treated differently from direct real estate ownership

A REIT is a corporation or trust that pools investor money to buy and manage real estate. When you buy REIT shares, you own a fractional stake in the company, not in the underlying properties. The REIT holds the deed, pays the property taxes, and handles maintenance. You receive dividends from the REIT's rental income and capital gains, but you have no direct claim to any specific property.

From a tax perspective, this matters because the 1031 exchange was designed to let investors defer tax when they move capital from one piece of real property to another. The assumption is that you are reinvesting in the same kind of asset — direct ownership of land and buildings. A REIT share is a financial instrument, similar to a stock or mutual fund, even though the underlying assets are real estate.

The IRS has consistently ruled that REIT shares do not may have access to, and the Tax Cuts and Jobs Act of 2017 did not change this. Some investors have argued that REIT shares should count as like-kind property because they represent real estate, but the IRS and courts have rejected this argument.

How to move from direct real estate into a REIT if you want to

If you own rental property and want to shift into REIT shares, you have two paths: sell the property and pay tax on the gain, or use a 1031 exchange to buy another piece of real property first, then later sell that property and buy REIT shares.

The first path is straightforward. You sell the property, calculate your capital gain, and pay federal and state income tax on it in the year of sale. You then have the full after-tax proceeds to invest in REIT shares or anything else. This is the simplest route if you are ready to exit real estate ownership.

The second path defers tax once but not twice. You sell your original property through a 1031 exchange and buy a different piece of real property. This defers tax on the first sale. Years later, when you sell the replacement property, you owe tax on the gain from that sale. At that point, you can use the proceeds to buy REIT shares, but that second transaction is taxable. You do not get a second tax deferral.

The difference between a 1031 exchange and a REIT for tax purposes

A 1031 exchange defers capital gains tax indefinitely — or until you sell the replacement property for cash. A REIT generates ordinary income tax on dividends and capital gains tax when you sell the shares. These are different tax treatments.

REIT dividends are taxed as ordinary income at your marginal tax rate, which is usually higher than the long-term capital gains rate. If you hold REIT shares for more than one year before selling, the gain on the sale is taxed as a long-term capital gain. But you cannot defer this tax the way you can with a 1031 exchange.

Some investors use a 1031 exchange to buy a property, hold it for several years, then sell it and buy REIT shares because they want to shift from active property management to passive investment. This is a valid strategy, but the second transaction (selling the property and buying REIT shares) is taxable.

Alternatives if you want real estate exposure without direct ownership

If you want to exit direct real estate ownership but stay invested in real estate, you have options that do not involve a 1031 exchange. You can buy REIT shares directly through a brokerage account, buy a mutual fund or exchange-traded fund (ETF) that holds REITs, or buy shares in a real estate mutual fund. None of these trigger a 1031 exchange, so you will owe tax on the gain from your original property sale.

Another option is a Delaware Statutory Trust (DST), which is a legal structure that can hold real property and may may have access to for 1031 treatment in some cases. A DST is a passive investment in real property managed by a trustee. You buy a fractional interest in the trust, which owns the underlying property. Some DSTs are marketed as 1031-may have access to replacement property, but this is a complex area and requires careful review of the trust documents and IRS guidance. Consult a tax professional before using a DST in a 1031 exchange.

What to do if you have already sold property and want to buy a REIT

If you sold real property and did not use a 1031 exchange, you owe tax on the gain and can use the after-tax proceeds to buy REIT shares without any restriction. If you sold property through a 1031 exchange and bought replacement property, you can later sell that replacement property and buy REIT shares, but that second sale is taxable.

If you are in the middle of a 1031 exchange (you have sold property but not yet closed on replacement property), you cannot change course and buy REIT shares instead. Once you have identified replacement property in writing within 45 days of the sale, you are committed to the 1031 path. If you want to buy REIT shares instead, you must let the 1031 exchange fail, which means you will owe tax on the original sale.

Frequently Asked Questions

Can I use a 1031 exchange to buy shares in a REIT that owns commercial property?

No. The type of real estate the REIT owns does not matter. REIT shares are securities, not real property, so they do not may have access to as like-kind replacement property under 1031 rules, regardless of whether the REIT invests in office buildings, apartments, warehouses, or any other type of real estate.

What if I buy a property through a 1031 exchange and then sell it to buy REIT shares?

The first transaction (the 1031 exchange) defers tax on your original property sale. The second transaction (selling the replacement property to buy REIT shares) is taxable. You will owe capital gains tax on the gain from the replacement property sale in the year you sell it. You do not get a second tax deferral.

Is there any way to defer tax when moving from real property to a REIT?

No. Once you decide to buy REIT shares, you must pay tax on any gain from the sale of the property that funded the purchase. A 1031 exchange only works if you reinvest in direct real property ownership. If you want to shift into REIT shares, you will owe tax on the gain from your original property sale.

Can I use a 1031 exchange to buy a partnership interest in a REIT?

No. A partnership interest in a REIT is still a security interest in a company that owns real estate, not direct ownership of real property. It does not may have access to as like-kind property for 1031 purposes.

What is a Delaware Statutory Trust, and can I use it in a 1031 exchange?

A Delaware Statutory Trust (DST) is a legal structure that holds real property and distributes income to investors. Some DSTs are marketed as 1031-may have access to replacement property, but this is a specialized and complex area. The IRS has issued guidance on DSTs, but each situation is different. Consult a tax professional or attorney before using a DST in a 1031 exchange to confirm it meets the requirements.