How To Identify 1031 Exchange Replacement Properties: 12 Cash Flow Rules

Are you doing a 1031 exchange and need to find replacement properties that cash flow? To help you learn how to identify 1031 exchange replacement property smartly and quickly, we’ve rounded up 12 rules that help you make the best investment decisions for your real estate investing goals.

There are so many reasons why real estate investors choose to do 1031 exchanges. For some, it’s an opportunity to build greater wealth by finding replacement properties in up-and-coming markets with a high chance for appreciation. For others, it’s a chance to create financial freedom by boosting their monthly cash flow, giving them the means to retire, travel the world, and spend more time with children or grandchildren.

Many investors choose to sell their appreciated properties in high-cost markets like California, New York, or Washington State, where cash flow is minimal but equity is substantial. Through a tax-free strategy, called a 1031 exchange, they can defer capital gains taxes and redirect that equity into multiple cash-flowing properties in landlord-friendly states.

Example: A $800,000 California property generating $500/month in cash flow can be exchanged for 4 duplexes in Alabama, each worth $200,000 and collectively generating $3,000+/month—a 6x increase in monthly income.

To begin, there are three general rules to follow when identifying replacement properties. They include:

The Three Property Rule states that, in a delayed exchange, the exchangor has 45 calendar days from the date the relinquished property closes to identify a replacement property. Under this rule, you may identify up to three properties of any value, as long as you purchase one of these properties within the 180-day exchange window.

The 200% rule allows you to identify more than three properties, but the combined value of these properties cannot exceed 200% of the relinquished property’s value. If you use this rule, we recommend creating a little padding (180-190%) so you don’t go over the 200%.

If you choose the 95% exception rule, you can identify any number of properties, and you don’t need to take the sale price of the relinquished property into account… if you actually acquire AND close on 95% of the value of the properties you identify. Be careful with this one. If you acquire less than 95%, your entire exchange will be invalid.

When looking for 1031 exchange replacement properties that will cash flow, here are a few more rules we generally follow. These cash flow rules are not specific to doing a 1031 exchange, but are important for anyone looking to purchase cash-flowing rental property. However, if you are looking to find replacement properties for a 1031 exchange that will cash flow, you should consider following these rules. 

When identifying 1031 exchange replacement properties that will offer strong cash flow, we look for real estate markets with population growth. Population growth is a good sign for potential cash flow because, typically, about 40% of a city’s population will be made up of renters. As the population grows, the demand for rental properties grows correspondingly.

We also look for real estate markets that are experiencing job growth. This follows the same logic as population growth, because typically, as more jobs are created, more people move to an area. In other words, job growth causes population growth.

Real estate markets that are retirement destinations, like Southern Florida, may not show significant job growth, but they do show population growth. These areas would still be considered strong cash flow markets.

When looking to generate cash flow, you don’t want to overspend on your investment property. Choose a real estate market that offers affordable housing prices and about a 1% price-to-rent ratio.

Markets like Alabama, Cleveland, and Jacksonville offer strong affordability entry points. Explore available properties in these markets →

When doing a 1031 exchange, you need to be able to identify replacement properties quickly and close within 180 days. Because of this deadline, it’s important to choose a market that has a good amount of inventory, so you’re not losing out during bidding wars.

Choose markets that have lower property taxes in order to increase your monthly cash flow. For example, cities in Alabama, such as Birmingham or Huntsville, might be great options because the state’s property tax rate is just 0.35%.

Compare property taxes and cash flow across all top 1031 markets here →

When seeking cash flow, it’s also important to target landlord-friendly states. An ideal market would be one with no rent control initiatives and where it isn’t insanely difficult to evict problem tenants. For example, California, a highly regulated state, may not be the best option to buy replacement properties, especially if you’re a newer investor.

Learn more about doing a 1031 exchange from California to another state.

When identifying cash-flowing 1031 exchange replacement properties, it’s also essential to choose the right kind of property. For example, a duplex will generate more cash flow than a single-family rental. Even if one side is vacant, you still have income coming in from the other unit.

For example, if you only invest in single family rentals (one door), your 10 loans will amount to 10 doors. However, if you were to invest in duplexes (two doors), you’d get 20 doors with 10 loans. A fourplex is an even better opportunity for cash flow, but it costs significantly more ($500,000 to $900,000 versus $200,000 to $300,000).

There are certain times of year that are better for cash flow than others. Ideally, you want these prime-time cash flow periods to line up with the close of escrow on your replacement property for your 1031 exchange.

Here are a couple of tips:

• Unless your turnkey property has tenants in place, avoid closing during November and December, as it can be hard to find people looking to move during the holidays.
• In some markets, like Pittsburgh and Dallas, it can also be harder to find tenants during football season. People don’t want to spend their weekends looking at rentals when their favorite college team is playing on Saturdays and NFL games are their priority on Sundays. This is especially true in markets like Pittsburgh and Dallas.
• To maximize your cash flow, time your close for February or later, because there’s no football and no holidays during this period.
• In February, people start to get their refunds from the IRS, so many prospective tenants have money for security deposits.
• You may also want to consider staggering duplex purchases by a month or so to avoid vacancies at the same time.

If you’re really looking to maximize cash flow with replacement properties, consider investing in Section 8 housing, which is government-subsidized. Learn about the pros and cons in Is Section 8 Good For Landlords or Not?

• Research target markets using the cash flow rules
• Connect with turnkey property teams in 2-3 markets, all vetted through our 7-step process before they ever meet our investors
• Review available inventory and pricing
• Hire a Qualified Intermediary
• Find a lender

• Formally identify up to 3 properties in writing to your QI
• Go under contract on your top choice (with contingencies)
• Complete inspections and due diligence

• Finalize financing
• Close on replacement property
• Begin the tenant placement process

Ed & Ann’s 1031 Exchange Success Stories

#1: Ed (Maryland → San Antonio, Texas)

• Real data: Sold for $340K, bought $624,900 duplex in San Antonio
• 2.8x cash flow increase ($2,000/year → $5,592/year)
• Went from 1.2% ROE (return on investment) to 3.6% ROE
• Hands-on to hands-off management
• Got a special 3.75% financing rate through RealWealth’s network

#2: Ann (San Diego → Alabama)

• Real data: Sold $930K STR in San Diego (negative cash flow!)
• Bought four properties across Alabama for $957,900
• Went from NEGATIVE cash flow to $29,483/year positive
• 9.8% return on equity
• Diversified across 4 Alabama cities (Huntsville, New Market, Birmingham, Bessemer)

Read more 1031 exchange success stories.

Need help Finding replacement properties fast?

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Yes, you can purchase replacement properties in more than one state. This is a good idea, especially if the property you plan to relinquish is on the pricier side. 

See how one investor diversified into multiple markets and doubled his portfolio →

We covered this a bit above already, but we’d typically recommend duplexes for replacement property if your goal is cash flow. Duplexes are still affordable, but they offer a larger income potential on a single loan.

Access our network of turnkey properties available for quick closing →

No, it’s not too late! Ideally, you’d want to have at least an idea of what replacement properties you’d like to purchase before you close on your 1031 exchange. But it’s still possible to find cash-flowing properties with little notice, especially if you work with an expert like RealWealth, who has vetted property teams with turnkey properties for sale now.

• Complete 1031 Exchange Rules & Definitions – Learn about critical IRS rules
• 1031 Exchange Timeline: 8-Step Process – Understand every deadline
• Qualified Intermediary Guide – Find the right QI for your exchange
• How RealWealth Vets Turnkey Teams – See the 7-step process every property team goes through

• Browse 1031 Properties in Top Markets – Dallas, Alabama, Jacksonville, Cleveland, Oklahoma City, Kansas City & More
• California to Out-of-State Exchange Guide – Increase cash flow 6x

• How I Doubled My Portfolio with a 1031 Exchange – Joe Torre’s case study

• Watch the 1031 Exchange Masterclass – Complete rules, timeline, and Q&A

Get Expert Help With Your 1031 Exchange

Finding cash-flowing replacement properties within 45 days doesn’t have to be stressful. RealWealth investors get: