Can You Use a 1031 Exchange for Foreign Property?

Many investors who own real estate outside the United States wonder if they can take advantage of the tax-deferral benefits offered by Section 1031 of the Internal Revenue Code. After all, if the property is used for business or investment purposes, shouldn’t it qualify?

The short answer is: 1031 Exchanges generally apply only to real property located within the United States. Let’s break down why that is — and what investors need to know when foreign property is involved.

Domestic vs. Foreign Real Property in a 1031 Exchange

According to Internal Revenue Code Section 1031(h), the exchange of property located in the U.S. for property located outside the U.S. (or vice versa) does not qualify for tax deferral.

This means that even if both properties are held for investment or productive use in a trade or business, exchanging between domestic and foreign real estate does not meet the “like-kind” requirement.

In other words:

• A U.S. property can be exchanged for another U.S. property, and

• A foreign property can be exchanged for another foreign property,

  but a U.S. property cannot be exchanged for a foreign one under Section 1031.

Why the Restriction Exists

Prior to the Tax Reform Act of 1989, exchanges between U.S. and foreign properties were sometimes treated as like-kind. However, Congress amended the rule to prevent tax deferral when property moves across national boundaries.

This change was meant to ensure that U.S. tax-deferred gains stay tied to domestic reinvestment — supporting the U.S. economy rather than allowing deferred gains to shift into offshore assets.

Examples of What Qualifies and What Doesn’t

• ✅ Allowed: Exchanging an apartment complex in France for a retail building in Spain (both foreign and held for investment).

• ✅ Allowed: Exchanging a rental property in California for a commercial property in Texas (both domestic).

• ❌ Not Allowed: Exchanging a rental property in Florida for a vacation rental in Mexico.

The distinction depends entirely on location, not the type of property or its use.

Tax Considerations for U.S. Investors Owning Foreign Property

Even though foreign properties cannot be part of a 1031 Exchange involving U.S. real estate, U.S. taxpayers who sell overseas investment properties still have tax obligations.

• Capital gains taxes on worldwide income generally apply to U.S. taxpayers, even for foreign property sales.

• Some may qualify for foreign tax credits or treaty benefits to offset double taxation.

Because international transactions can trigger both U.S. and foreign reporting requirements, consulting a tax advisor experienced in cross-border real estate is strongly recommended.

Draw the Line

For 1031 Exchange purposes, “like-kind” means both properties must be located within the same country — either both in the United States or both outside it. The IRS does not permit mixing domestic and foreign real estate in a single exchange.

Investors who own foreign property should plan carefully and explore other tax strategies to manage gains from international sales.

Disclaimer
This article is for informational purposes only and does not constitute legal or tax advice. Always consult a Qualified Intermediary or tax professional before initiating a 1031 Exchange or selling foreign property.