Can a Foreign Investor Do a 1031 Exchange?

The short answer is yes. A 1031 lets you sell a US rental and buy another without paying tax on the gain, and nothing in the rule says you must be American.

The longer answer is that there is a clash at the heart of it that catches almost everybody. I sold dozens of my own US rental properties in 2023, and I was unable to do a single 1031 exchange.

A 1031 needs every dollar of your sale money to pass through a qualified intermediary and into the next house. FIRPTA needs the buyer to hold back up to 15% of the gross price and send it to the IRS.

Both cannot happen. And unless you sort that out months ahead, the held-back money is not there to buy the next house, the swap is only part done, and you owe tax on the gap.

Several exchange firms name this as a common myth: that a foreign seller doing a 1031 avoids FIRPTA. You do not.

1. What does a 1031 exchange actually do?

A 1031, named after the code section, lets you sell an investment house and buy another without booking the gain. The tax is put off rather than waived, and it rolls into the new house until you sell one day without swapping.

The tax bill you are deferring is built from basis and the recapture of depreciation, and the running costs that shaped that basis are in maintenance, repairs and capital. Where it sits among everything else the US taxes a foreign owner on is in my US tax guide for foreign investors.

All the normal rules apply to you just as they do to an American citizen.

You must use a qualified intermediary, who holds the proceeds. You may never touch the money. You have 45 days from closing to identify the replacement property in writing, and 180 days to complete the purchase. The replacement must be of equal or greater value, and all the proceeds must be reinvested.

And one thing makes it worth more to us than to many Americans. A 1031 also puts off depreciation recapture, not just the gain. On a typical US rental property held for years, recapture at 25% is often almost the whole US tax bill, as I set out in the depreciation advice that costs foreign investors thousands. Deferring it matters.

2. Why does FIRPTA break a 1031?

Here is the problem.

A 1031 needs all of your money to go from the closing to the intermediary and then into the next house.

FIRPTA takes up to 15% of the gross sale price and sends it to the IRS.

Take a $145,000 sale, which is the Kansas City house I have used across various case studies on this blog.

So $21,750 of your own money cannot go into the next house. In swap language that gap is called boot, and boot is taxed. You did a 1031 and yet still got a tax bill.

One published case makes it clear. A French seller sells a $1 million house, the buyer holds back $150,000, and unless the IRS has signed off the certificate before the next house closes, that money is simply not there.

3. What are the two ways round it?

You only have two options that I am aware of, and both need planning.

A withholding certificate, obtained before closing

File Form 8288-B before the sale and ask the IRS to cut the withholding to your real expected tax bill. In a fully deferred swap that tax is nil, so an approved certificate can take the withholding to zero and let all the money reach the intermediary.

The problem is time. Exchange specialists put the wait at 90 days or more, and the certificate has to be approved before the replacement closes to be useful. Under Rev. Proc. 2000-35 the IRS should act on a complete application within 90 days, but that clock starts when the application is complete, and it needs your tax number first.

And you must tell the buyer in writing that you have asked for one. This alone can create problems if a buyer feels the transaction is getting complicated.

Bringing outside cash

The simpler and clumsier answer. Put your own money with the closing agent to cover the withholding, so the whole sale price flows to the intermediary and the swap completes with no boot.

On the $145,000 sale that means finding $21,750 of other cash for the length of the process, and getting it back later when you file. It works, it needs no IRS sign-off, and it needs cash you may not have.

There are a few other considerations. If you are using a mortgage for the new purchase, the source of those funds matters, and certain sources can block your financing entirely, as I have set out in how to fund a US property purchase.

Neither route is hard. Both need you to have started before you took an offer.

4. Does the type of exchange change the withholding?

There are a couple of ways to do a 1031: a same day swap, and a delayed swap.

In a same-day swap, where both closings happen at once, the buyer need not withhold if two things are done. The seller gives the buyer written notice that no gain is booked because of section 1031. And on the 20th day after, the buyer sends a copy to the IRS.

The buyer can rely on that notice, but only if the foreign seller gets no cash and no mortgage boot. Any boot and the relief goes.

In a delayed swap, which is what almost everybody does, the buyer may have to withhold and file Form 8288 anyway. That is the common case, and the one where you need the certificate or the outside cash.

So if somebody tells you a 1031 gets you out of FIRPTA, ask which kind of swap they mean. The relief exists, and it almost certainly does not apply to yours.

5. When do I need to start?

Working backwards from the sale, which is the only way to get this right.

Almost nobody plans six months ahead of a sale. I certainly did not. At the time, I was selling because I had to. Which is why most foreign sellers who want a swap end up funding the withholding themselves or dropping the swap.

And one thing to bear in mind: your ITIN is the gate everything else waits behind, and the same gate that holds up FIRPTA refunds, which I have written about in how to get your FIRPTA money back.

6. Is it worth it on a modest gain?

Here is the question nobody selling these services asks, and the answer turns on the size of your gain.

Take the Kansas City house I mentioned above. A $145,000 sale, ten years held, with a US tax bill of $6,242 of which $6,182 is depreciation recapture. How that bill is built, on a larger sale, is in capital gains tax when a foreign owner sells. The whole ten year model, including what the property earned along the way, is in selling a US rental as a Canadian.

About $3,492 of deferral. In return you take on a 45 day deadline to name the next house, a 180 day deadline to buy it, and a process that fails if you miss either. Miss the 45 days and you owe the tax anyway, plus the fees.

And those are only the exchange fees. The cost of the sale itself, and of the purchase at the other end, is a separate bill, set out line by line in what closing costs actually are.

But now scale the gain.

In my opinion the breakeven happens somewhere around a $75,000 gain. Below that the fees and the timing risk eat most of the benefit and I would not bother. Above it, the deferral is real money and worth planning six months out.

One more thing to weigh. A 1031 puts the tax off, it does not remove it. You trade a known bill now for a bigger one later, betting that you keep swapping or that your rate is lower when you stop. And if you never stop, the property is still in your estate, where a different bill waits, set out in US estate tax for foreign property owners. Usually a sound bet. Still a bet.

And note what you are putting off. On a long hold it is almost all depreciation recapture, and if you are a UK resident that depreciation was worth close to nothing to you anyway, for reasons set out in selling a US rental as a UK resident. Putting off the clawback of a deduction that never helped you is still worth doing. Just know that is what you are doing.

7. What would I do before selling?

Five things, and the first two are the ones people skip.

Decide before you list, not after you take an offer. Everything here has a lead time. If you hold through an LLC, its own annual filing carries on regardless, which I have set out in the $25,000 form nobody mentions.

Get the ITIN now, whether or not you are selling. It is the gate for the certificate, the exchange, the refund and your annual return, and for stopping the 30% withholding on your rent while you hold, which is in how to stop the 30% withholding. My client Karl went through the same paperwork buying his first US rental from Taiwan, which is set out in his case study, and it is far easier to do at purchase than under a deadline.

Use a qualified intermediary who has done this with foreign sellers, and ask how many. Canadians should also check what claiming CCA at home has done to the position, which is in should Canadians claim CCA on a US rental. The mechanics are the same but the FIRPTA layer is not, and it is no place for somebody learning.

File the 8288-B early or budget the outside cash. One or the other. Decide which and plan for it, because finding out at closing that $21,750 has gone to the IRS is not a problem you fix on the day.

And check the sum first. If your gain is modest, the honest answer may be to pay the tax, keep your freedom, and buy the next house without a 45 day clock running.

If you want to size the tax before deciding, the FIRPTA withholding calculator will give you both the withholding and the real liability, and the free tools in my investor starter kit cover the deal itself. If you would rather have the sale and the next purchase coordinated for you, that is part of what our purchase service does.

The bottom line

Foreign investors can do 1031 exchanges, and there is no residency test. What there is, is a clash between two rules that nobody warns you about, and a timing issue.

FIRPTA wants up to 15% of your gross sale price. The 1031 exchange wants 100% of your money. Sort that with a certificate obtained months ahead, or by bringing your own cash to closing, and it works exactly as it does for an American.

Fail to sort it and you have paid fees to achieve a part deferral and a tax bill.

And ask whether it is worth it at all. On a modest rental the benefit after fees may be a few thousand dollars, bought with two hard deadlines and no room for error. Above roughly a $75,000 gain the answer changes completely.

Remember, investing is a game of probabilities. Deadlines are not. They pass whether you were ready or not.