The 1031 exchange for Maryland investors.

A properly executed Section 1031 like-kind exchange defers both federal and Maryland state capital gains taxes on an investment-property sale. The combined deferral can exceed 30% of the gain — but the deadlines and procedural rules are unforgiving.

1. What a 1031 exchange does

Section 1031 of the Internal Revenue Code allows an investor to sell an investment property and reinvest the proceeds into a "like-kind" replacement property without immediately recognizing capital gains. The tax isn't eliminated; it's deferred until you eventually sell without exchanging (or, under current law, eliminated entirely at death via stepped-up basis to your heirs) [1].

Maryland honors federal 1031 treatment for state income tax purposes. That means a successful exchange defers both federal and Maryland state and county capital gains taxes [1].

2. The Maryland tax stack you're deferring

Maryland investors face an aggressive combined-rate tax burden on investment-property gains [1]:

• Maryland state income tax: up to 5.75% (highest bracket).
• Maryland county "piggyback" tax: up to ~3.2% depending on county.
• Federal long-term capital gains: 15–20% depending on income bracket.
• Net Investment Income Tax (NIIT): additional 3.8% for higher-income taxpayers.
• Depreciation recapture at 25% federal rate.

On a $200,000 gain after depreciation recapture for a high-bracket Maryland investor, the combined federal-plus-state-plus-county tax burden can exceed 32% — meaning a properly executed 1031 can defer $60,000+ in taxes on that sale alone [1].

3. What qualifies

Both the relinquished property (the one you're selling) and the replacement property must meet 1031 criteria:

• Held for investment or productive use in trade or business. Your primary residence does not qualify. Investment properties, rental properties, vacant land held for investment, and certain business real estate do.
• Like-kind is broadly defined for real estate. Apartment building → single-family rental → commercial → land are all like-kind to each other.
• U.S. real property only. Foreign property is not like-kind to U.S. property after the 2017 Tax Cuts and Jobs Act.
• Equal-or-greater value rule. To fully defer all gain, the replacement property's value must be equal to or greater than the relinquished property's, and all proceeds must be reinvested. Partial exchanges trigger "boot" — partial recognition of gain.

4. The 45-day and 180-day rules

Two hard deadlines start the moment you close on the sale of the relinquished property [2]:

• 45 days to identify potential replacement property(ies) in writing to your qualified intermediary.
• 180 days to close on the replacement property.

These run concurrently, not sequentially. The 180 days starts on the day of the relinquished-property sale, not the day after identification. There are no extensions except in presidentially-declared disaster areas [2].

The identification rules:

• Three-property rule: identify up to three properties of any value.
• 200% rule: identify more than three properties as long as their combined value doesn't exceed 200% of the sold property.
• 95% rule: identify any number of properties of any value, but you must close on properties representing 95% of the total identified value.

5. The qualified intermediary requirement

The IRS requires a qualified intermediary (QI) for any non-simultaneous exchange (which is essentially all of them in practice). The QI [2]:

• Receives the sale proceeds from the relinquished property — the seller never has "constructive receipt" of the funds.
• Holds the funds in a segregated account during the exchange period.
• Acquires the replacement property and conveys it to the exchanger at closing.
• Provides the documentation needed for the exchanger's tax return.

The QI cannot be a person with a prior fiduciary or agency relationship to the exchanger — meaning you cannot use your attorney, CPA, real estate agent, or family member as your QI. Specialized 1031 QI firms exist; vet for bonding, segregated accounts, and reputation.

6. How a 1031 actually works, step by step

1. Decide before listing. The exchange must be structured into the sale contract. Once you've closed and received funds, the option is gone.
2. Engage a QI before the closing of the relinquished property.
3. Sell the relinquished property. Sale proceeds go to the QI's escrow, not to you. Day 1 of both timelines starts.
4. Identify replacement property in writing to the QI by Day 45.
5. Close on the replacement property by Day 180 using the QI-held funds.
6. File IRS Form 8824 with the tax return for the year of the exchange.

7. Common pitfalls

• Missing the 45-day window. Most failed exchanges fail here. Have your replacement candidates lined up before you list the relinquished property.
• "Boot" reducing the deferral. If you take any cash out, or if the replacement is worth less than the relinquished, you owe tax on the difference.
• Personal-use property. A vacation home you stay in personally may not qualify; consult your CPA on facts and circumstances.
• Related-party exchanges. Exchanges with a related party trigger additional rules — both parties typically must hold the swapped property for two years.
• Choosing the wrong QI. A QI failure or fraud (yes, this has happened) can blow up the whole exchange and leave you taxed. Vet thoroughly.
• Not coordinating with the buyer's lender. Some lenders are slower than the 180-day window allows. Make sure your replacement financing is teed up early.

Section 1031 is a complex tax statute with strict procedural requirements. This guide is general information and is not tax, legal, or investment advice. Always consult a qualified CPA and an attorney with 1031 experience before engaging in an exchange, and engage a reputable qualified intermediary before the closing of the relinquished property. Evan Kundrat is a Maryland-licensed real estate salesperson (Lic. #5003434) at Keller Williams Flagship of Maryland (Designated Broker: Barry Hess, Lic. #517943). Equal Housing Opportunity.

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