Everything You Need to Know About 1031 Exchanges

1031 Exchanges

Real estate investors can take advantage of an important tax break when they sell income-generating real estate held for investment purposes, provided they are willing to keep their money on the table and not cash out any of the sale proceeds.

By completing a 1031 exchange – selling an investment property and rolling the sale proceeds into another like-kind property – investors can defer any realized capital gains taxes generated from the sale of appreciated investment properties. The strategy sounds pretty straightforward in concept, but executing a successful 1031 exchange can be quite complicated.

The information below is a comprehensive guide on 1031 exchanges that provides insight into the many rules, timelines and stipulations associated with like-kind exchanges to help you map out and potentially execute a successful 1031 exchange strategy.

What is a 1031 Exchange?

A 1031 exchange is basically a property swap that allows you to defer any capital gains tax liability generated from selling an investment property for a profit. The name is taken from Section 1031 of the Internal Revenue Code. Exchanges have been successfully completed since the early 1920s, although today they are limited strictly to real property assets that have been held for investment purposes or used in business and trade.

In a straight sale, investors who divest appreciated real estate generate an immediate tax liability when the asset sells for more than its adjusted cost basis. However, by executing a 1031 exchange – rolling over the entirety of sale proceeds from the relinquished property into a like-kind replacement asset – you are allowed to defer capital gains and depreciation recapture taxes. The exchange process can continue indefinitely – you can keep swapping investment properties until you die, and if you’ve bequeathed an exchange property to your heirs, they will receive a one-time step-up in basis to fair market value that may potentially wipe out any rolled-over tax liabilities.

If you decide to sell a property you acquired to complete a 1031 exchange, however, those deferred capital gains taxes come due.

5 Benefits of 1031 Exchanges

Deferring capital gains taxes is usually considered the primary benefit of executing a 1031 exchange, but there are many other ways a successful 1031 exchange can potentially work in your favor.

1. Bigger may be better

   Deferring capital gains taxes allows you to leverage more of your investment capital, so you potentially can acquire larger properties with increased valuations. These higher-value or better-quality assets may have the potential to deliver increased cash flow and greater overall returns.

2. Portfolio diversification

   The words like-kind are a bit of a misnomer. In actuality, replacement properties are quite fungible. You don’t have to exchange a duplex for another duplex, or a freestanding retail building for another retail property. You can exchange an office building for a small storage facility, or a single-family rental for a triplex, provided you always trade across or up in value. This interchangeability of asset type allows you great leeway that can lead to increased portfolio diversification by asset class.

3. Geographical diversification and reduced taxation

   You can swap properties across state lines, which may enhance your portfolio’s geographical diversification. Geographical diversification can also lead to reduced tax liability. Investors who exchange investment real estate in markets with high taxes, such as New York and California, into more tax-friendly states could realize reduced taxation on their real property assets. Your investment capital may also stretch much further in tertiary markets than in primary markets that often have extremely high real estate valuations.

4. Risk management

   A 1031 exchange can be used as a risk management tool. You can exchange out of markets or neighborhoods where tenant vacancy is high due to waning consumer interest, and into flourishing markets with demonstrated job and population growth. You can also attempt to manage risk through increased diversification by geographical location and asset class.

5. Reduced oversight

   Exchanging from multiple properties into a single asset can lead to less oversight and time spent managing your assets.

You may realize several other additional benefits when executing a 1031 exchange – it truly depends on your investment goals and financial situation.

Understanding the Basics of 1031 Exchanges

Let’s dive into the real nuts and bolt of how 1031 exchanges work.

Eligible properties

The main stipulation from the IRS for eligible 1031 exchange properties is that they must be of the same nature or character. You can exchange different asset classes, as well as different grades and quality of real estate.

The main caveat is that exchange properties must be held for investment purposes, or for use in trade or business. Generally speaking for 1031 exchange purposes, most real estate is considered like-kind. An apartment building is like-kind to a triple-net free standing retail building, and a medical office building is like-kind to three single-family rental homes, even though these properties are very different asset classes. You are also eligible to exchange a 1970s Class C apartment complex for a new Class A property, or an new industrial building for an older asset provided property values and mortgage debt align.

One last note on eligible properties: You can exchange active ownership for passive ownership by purchasing beneficial interests in a Delaware Statutory Trust (DST) – see the section below on DSTs for a detailed overview of this 1031 exchange strategy.

Timeframes and deadlines

There are two extremely important deadlines associated with 1031 exchanges.

1. 45-day Identification rule

   After the close of sale on your relinquished property, you have 45 calendar days to formally identify a potential replacement property. You can identify and purchase multiple properties, which can be especially helpful if exchanging out of a higher-value asset and are struggling to find replacement properties of matching value – but there are some guidelines to which you must adhere:

   • Three-property stipulation. You can formally identify up to three replacement assets, regardless of value, and you must close on at least one property.

   • 200-percent stipulation If you have to formally identify more than three properties to complete your 1031 exchange, the aggregate value of the assets cannot exceed 200 percent of the market value of your relinquished property.

   • 95-percent stipulation This is the least-used identification rule. You can identify more than three properties whose aggregate value exceeds 200-percent of your original investment asset, but you have to close on 95-percent of the value of the properties you’ve identified.

2. 180 days to close

   Now that you’ve used one of the formats above to formally identify your replacement property, you have 180 from the close of sale on your relinquished property to close on your replacement property.

   Simply stated, after selling an investment property, you have a month-and-a-half to identify a replacement property for your exchange, and six months to close on it. It’s also important to note that in order to meet the 45-day identification timeline, you should have multiple suitable replacement properties on your radar before close of sale on your relinquished asset.

Role of Qualified Intermediaries

The role of Qualified Intermediaries (QIs) in 1031 exchanges is paramount to executing a successful exchange. QIs, also called exchange accommodators, are independent third parties that facilitate all stages of the exchange transaction to ensure investors adhere to IRS regulations. In addition to handling all the identification paperwork and other crucial exchange documentation, your QI holds all sale proceeds in a segregated escrow account. This separation ensures that investors never take constructive receipt of any sale proceeds during the exchange, since doing so invalidates the exchange and results in a straight sale and generates an immediate capital gains tax liability.

That’s a high-level overview of 1031 exchange basics. Below is a step-by-step outline of the process for executing a 1031 exchange.

The 1031 Exchange Process

This is a basic roadmap for the 1031 exchange process; your exchange is likely to have additional twists and turns depending on your financial situation, investment goals, mortgage debt, property selection, and similar related factors that are unique to each exchange.

Step 1: Selling the relinquished property

The simplest exchanges involve a one-for-one swap of like-kind investment properties, although you can exchange out of and into multiple properties. The first asset in the exchange is called the relinquished property (sometimes referred to as the downleg); the second is the replacement property (upleg).

It’s of utmost importance to initiate the 1031 exchange process prior to beginning sales proceedings on your relinquished property. Once you’ve met with tax and legal professionals to discuss the potential ramifications of the upcoming exchange, and you’ve got a Qualified Intermediary in place, you’re ready to begin the sales transaction for the downleg portion of your 1031 exchange.

You’ll create a sales contract assignable to your QI so that party can divest your original investment property as part of a 1031 exchange. This contract will also include a clause stating that property is part of a 1031 exchange and the buyer agrees to cooperate with exchange rules. At closing, your QI will receive funds either by wire transfer or check, and will hold all sales proceedings in an escrow account until they are needed to purchase a replacement property to complete the exchange. This separation ensures you stay on the sidelines during the exchange process and never take receipt of any funds involved in the exchange. The clock to complete the exchange begins on the day that sales proceedings on your relinquished property are completed.

Step 2: Identifying replacement properties

Now that your investment property has sold, you’ll have to determine which identification method best meets your 1031 exchange needs. Your Qualified Intermediary will help you complete the necessary paperwork and forms to ensure your targeted replacement assets are formally identified. Once you’ve made your selection, you can identify additional replacement properties so long as it’s done within that crucial 45-day window. Target assets must be unambiguously described through their legal description or by property address in the identification documentation, which must be signed by the same taxpayer that’s undertaking the 1031 exchange. This documentation typically is received by your QI, but it also may be sent to the seller of the replacement property, an escrow agent, or title company depending on how your exchange proceedings are structured and play out.

Step 3: Closing on the replacement property

You can only acquire formally identified replacement properties to complete your exchange. You’ll create an assignable purchase contract that allows your Qualified Intermediary to buy the replacement property. This contract will include language noting that the seller agrees to cooperate with your exchange requirements. The seller and your QI will execute the purchase transaction, and once all documentation is complete and you’ve agreed upon a closing date, you’ll complete a request for funds form so that your QI can disperse funds at the closing table. The exchange is complete and the taxpayer recognizes 100-percent deferral of capital gains taxes if the entirety of the funds from the relinquished property are used to purchase the replacement asset. Your taxation professional will report the exchange using Form 8824 in the year the exchange was completed.

5 Common Pitfalls to Avoid During a 1031 Exchange

There are a number of pitfalls to avoid before and during the exchange process:

1. You can’t begin an exchange after close of sale on your original investment property; at that point, it’s deemed a straight sale, and you are liable for any capital gains and depreciation recapture taxes.
2. You might find yourself hard-pressed to find a suitable replacement property within 45 days after closing, so you’ll want to line up some potential assets for formal identification before the sale process begins.
3. Your Qualified Intermediary has to facilitate all aspects of the exchange. Most notably, your QI has to take possession of all sale proceeds from your relinquished property and purchase the replacement asset in order to adhere to IRS 1031 exchange regulations.
4. You’ll have to trade up or across in property value in order to avoid creating taxable boot.
5. Mortgage debt on the downleg and upleg properties must align.

Different Types of 1031 Exchanges

There are quite a few different types of 1031 exchanges. We’ll go into detail on the most prevalent exchange strategies:

• Delayed exchange

  This is the most common type of 1031 exchange. It’s also known as a forward exchange. You’ll sell an investment property, identify a replacement property within 45 days, and close on it (or multiple replacement properties) within 180 days.

• Reverse exchange

  The reverse exchange strategy is used when you acquire a replacement property prior to divesting your relinquished property. This strategy often involves all-cash transactions.

• Simultaneous exchange

  Due to its higher execution risk, this exchange strategy is rarely used. You’ll have to close the sale of the relinquished and replacement properties on the same day.

• Improvement exchange

  Investors can deploy this strategy when they need to make capital improvements to a replacement property. Tenant improvements must be completed during the 180-day-to-close window.

• Installment sale

  Investors who need seller financing to purchase their replacement properties can combine a 1031 exchange with an installment sale. However, there are unique tax implications involved with this strategy that should be discussed in depth with a tax advisor prior to initiating this type of exchange.

1031 Exchange Rules and Regulations

We’ve highlighted many of the rules and regulations to which investors must adhere to complete a 1031 exchange, particularly with timelines and using a Qualified intermediary. There are some additional IRS guidelines and considerations regarding 1031 exchanges of which investors should be aware.

Additional IRS guidelines:

• Taxable boot

  If there’s cash leftover after purchasing your replacement property, you’ll receive those funds after the 180-day window closes. Those funds are called boot and are taxed as capital gains.

• Debt must align

  You can’t improve your financial position in an exchange, either, meaning mortgage debt must align on both properties. If debt is reduced on the replacement property, that money is treated like cash and taxed as ordinary income.

• Holding period

  Replacement properties must be held as an investment rather than for sale. Generally, a one- or two-year holding period is sufficient to provide safe harbor, but you may want to extend that period to ensure your exchange isn’t challenged or scrutinized by the IRS.

• Real property only

  Historically, you could include personal property in a 1031 exchange. That changed with the passage of the Tax Cuts and Jobs Act of 2017, which limited 1031 exchanges to real property.

• Use of a QI

  Using a Qualified Intermediary to facilitate your exchange is of paramount importance. You can’t facilitate the exchange yourself, nor can you use your attorney, real estate broker, accountant or any employee if you’ve worked with them in the past two years.

• Timelines

  The 45- and 180-day deadlines are pretty much concrete deadlines – don’t expect any type of extension outside of a federally declared disaster.

Prohibited properties

Primary, second and vacation homes are considered prohibited properties in 1031 exchanges because these assets generally are held for personal use rather than investment purposes. However, if you rent these assets out for a minimum of two years, they can become eligible for 1031 exchange treatment.

Substantial improvements

Improvement exchanges have additional requirements. All improvements must be completed within the 180-day window. Completed improvements must make the replacement property of equal or greater value than the relinquished asset, and they cannot change the underlying nature or characteristics of the replacement property.

Legal compliance

As a final tidbit of legal compliance, there are a host of rules regarding related persons in a 1031 exchange. Exchanging with a related party, such as linear blood relatives, spouses, as well as individuals or entities to which you are related, requires extreme diligence and adherence to these rules. For starters, both sides of the exchange must hold their properties for a minimum of two years to ensure the exchange isn’t voided. Additional IRS rules regarding related party transactions could create potential pitfalls with your exchange strategy, so it’s essential to discuss this type of exchange in depth with a qualified taxation and exchange professional.

Tax Implications of Completing a 1031 Exchange

The tax advantages of a successful 1031 exchange can prove beneficial on multiple levels.

• Deferring capital gains taxes

  As noted earlier, anytime you sell an investment for profit you generate a capital gain tax liability. Capital gains are taxed in two ways: short- and long-term. Short term gains are taxed at your nominal tax rate, while long-term gains are taxed at 0, 15 or 20 percent depending on your income and tax filing status. Selling a highly appreciated investment property could result in a significant capital gains tax bill, but you can defer those taxes by rolling over the entirety of your sales proceeds into another investment property. Taxes are deferred, not eliminated. Deferring money that otherwise would have gone to the IRS may allow investors to purchase assets of greater value and potentially earn greater returns on their investment capital.

  If you sell a property that was acquired to complete a 1031 exchange, any deferred capital gains taxes are immediately due.

• Depreciation recapture

  In a straight sale, depreciation recapture is taxed up to 25 percent of total depreciation deducted during the asset’s holding period. However, depreciation recapture, like capital gains, is deferred when you complete a 1031 exchange.

• State tax considerations

  Rules for state mandatory withholdings upon the close of sale of real property varies from state to state. For instance, California, Montana, Massachusetts and Oregon have claw-back rules that may apply to 1031 exchange properties that are later divested in taxable sales. Other states may allow withholding exemptions for exchange properties. Consult with a tax advisor to determine your personal tax scenario and state tax considerations.

Advanced 1031 exchange strategies

In some instances there may be some advanced exchange strategies that could prove beneficial for investors.

• Combining 1031 Exchange with Opportunity Zones

  One main caveat of 1031 exchanges is that the relinquished and replacement properties must be like-kind to each other. While there’s a lot of wiggle room in that definition in regards to asset type, class and grade, you still must exchange one or more pieces of real estate for another in order to defer capital gains taxes. Opportunity Zones also offer investors the ability to defer taxes on any type of capital gain by investing in a Qualified Opportunity Fund (QOF), but therein lies the problem with potentially combining the two tax-deferral strategies. A QOF is not considered like-kind to real property, so it’s not possible to blend a 1031 exchange with an Opportunity Zone investment.

• Partial 1031 exchanges

  It’s possible to take some cash out of a 1031 exchange if you need increased liquidity. A partial or split exchange may also be a good strategy for investors who struggle to identify suitable replacement properties with aligning values. Any funds you take out of the exchange are considered boot, though, and you’ll have to pay taxes on those funds depending on how it was generated.

• 1031 exchanges for estate planning

  Transferring exchange properties to your heirs upon your death allows them to inherit assets at a step-up in basis to their current fair-market value. This important estate planning provision could potentially eliminate or significantly reduce any deferred capital gains taxes on exchange properties.

Advantages and Disadvantages of 1031 Exchanges

Like-kind exchanges can offer a number of benefits, but there are potential drawbacks as well.

Pros of 1031 exchanges

Benefits of successfully executing a 1031 exchange may include:

• Deferral of capital gains and other taxes

  This is a primary reason why real estate investors exchange rather than sell investment properties. Capital gains, depreciation recapture, Affordable Care Act and state-level taxes could take as much as 35 percent of any profit generated on the sale of an investment property. A 1031 exchange defers these tax liabilities.

• Increased cash flow

  Exchanging into assets of greater value may present investors with opportunities for increased cash flow through higher monthly rental payments.

• Capital appreciation

  Well-positioned assets of higher value may realize increased asset appreciation.

• Greater purchasing power

  Retaining the entirety of sales proceeds after divesting an investment property keeps more capital in your pocket and allows you to seek replacement properties of greater value.

• Reduced management duties

  You can exchange out of multiple investment properties into a single asset to reduce management duties, or exchange into a passive ownership structure such as a Delaware Statutory Trust to eliminate management duties entirely.

• Diversification

  Exchanging into different asset types, classes and geographical regions can lead to increased portfolio diversification, and also potentially help investors manage concentration risk.

Cons and Risks

As with any investment, there can be some risks and potential drawbacks with a 1031 exchange. These can include:

• Missed deadlines

  Execution risk increases whenever you are facing hard deadlines. After closing the sale of your relinquished asset, the IRS allows 45 days to identify suitable replacement properties, and 180 days to close on them. Miss either deadline, and your exchange will fail.

• Qualified Intermediary

  Your exchange facilitator is like the quarterback of a football team. The QI calls in all the plays, runs point on sale and acquisition, and spearheads the entire exchange process. Choosing an experienced QI is paramount to the success of your exchange. Additionally, Qualified Intermediaries aren’t federally regulated, so there is an opportunity for financial malfeasance. Performing due diligence on your QI is as important as the due diligence you conduct on potential replacement assets.

• Complexity

  Undertaking a 1031 exchange is much more complicated and has far more regulations to which you must adhere than a straight sale. More steps means more opportunities to stumble.

• Illiquidity

  You can’t take cash out of a 1031 exchange without creating a taxable event. Exchanges only make sense for investors who don’t need access to capital.

• Taxes are only deferred

  With a 1031 exchange, you are basically kicking the can down the road – any tax liability generated from the sale of an appreciated investment property is merely deferred. If you divest the replacement asset in a straight sale at a later date, you’ll have to pay those deferred taxes.

Preparing for a 1031 Exchange

Preparing early for a 1031 exchange can help potentially manage execution risk. Following these steps well in advance of initiating sales proceedings on your investment property can help you in numerous ways.

Find an Experienced Qualified Intermediary

Due diligence on prospective QIs should include:

• Number of completed exchanges

  A large volume of successfully completed 1031 exchanges should equate to deeper experience with the intricacies of the exchange process.

• How and where your sales proceeds will be held

  Your funds should be held in a segregated escrow account at an FDIC-insured financial institution.

• Insurance

  Since the QI industry isn’t regulated, inquire if your prospective Qualified Intermediary offers errors and omissions insurance, fidelity bond coverage, or some other type of protection that can help safeguard your funds while they are held in escrow.

• Complex and non-traditional exchanges

  Does your QI have experience with partial, reverse, simultaneous and other more-complicated exchanges?

• Fee structure

  The fees QIs charge varies depending on whether they are institutional or non-institutional QIs. Make sure you know in advance how much your exchange accommodator will charge for their services.

• FEA member?

  QIs who are members of the Federation of Exchange Accommodators adhere to a rigorous code of ethics that govern their conduct and responsibilities.

Due Diligence in Property Selection

Comprehensive pre-offer due diligence allows you to gain crucial insight into important financial metrics of potential investment properties and determine if they meet your investment criteria. Common geographical market due diligence includes population, job growth, median household income, median rental statistics, vacancy, crime, and other metrics. Asset-level due diligence typically includes examining rent rolls, vacancy, deferred maintenance and predicted capital expenditures for necessary or major repairs, taxes and insurance, and financing options. For properties that meet your investment goals, you’ll also want to order inspections and environmental reports, and see if there are any outstanding liens on the property. The full scope of due diligence is likely unique to each investor and each property involved in a 1031 exchange.

Assembling Your Team

Your 1031 exchange team of course includes an exchange accommodator, but it also should include legal and tax professionals with experience in real estate law and taxation. Strategizing an upcoming exchange with the appropriate professionals before putting your investment property up for sale can help calm the waters and avoid any unexpected turbulence.

Tax Planning and 1031 Exchanges

A successful 1031 exchange requires strategic timing both in execution and in regards to how long you’ll want to hold the replacement property.

The IRS tax code on 1031 exchanges does not have a concrete timeline for asset holding period. However, it’s generally accepted that a one- or two-year holding period before selling or swapping for another exchange property will provide safe harbor for your exchange. Note that that timeframe is a suggested reasonable guideline – holding your property for longer and demonstrating a pattern of rental history will help avoid raising any red flags. Working with tax professionals who understand 1031 exchange tax strategies and implications can help you determine the best options and course of action to take with your exchange. Getting these professionals involved early in the exchange process and engaging them throughout the exchange can help you maximize your tax deferral and avoid any missteps.

1031 Exchange and Other Tax-Deferral Strategies

There are other strategies investors can deploy that provide important tax deferral benefits.

• QOFs

  Investors who have realized capital gains on any type of investment can defer taxes on those gains by investing in a Qualified Opportunity Fund, which in turn invests in Qualified Opportunity Zones. Tax defer strategies vary depending on how long you leave your money in the fund.

• IRAs

  Individual retirement accounts historically have served investors for decades. Contributions are tax-free and remain untaxed until you begin taking distributions during retirement.

1031 Exchanging into a DST for Portfolio Diversification

When considering a replacement property to complete a 1031 exchange, there is another option for investors – especially those who don’t mind segwaying into passive ownership – that may offer increased portfolio diversification.

Delaware Statutory Trusts are real estate investment vehicles that provide investors with access to commercial investment properties that may be significantly larger than what they could acquire on their own. DST properties are often the same type and quality of assets that are owned by pension funds, insurance companies, or real estate investment trusts.

Trust assets are sourced, acquired and professionally managed, so investors don’t have to carry the burden of any of those duties, which are typical of actively managed assets. DST Sponsors may focus on one or more sectors of the commercial real estate industry, such as multifamily apartment complexes, student and senior housing facilities, hospitality properties, or office, industrial warehouse, and distribution/fulfillment facilities – sectors that typically aren’t available to individual investors due to high cost of entry. These assets can lead to increased portfolio diversification.

Here’s two of the most important aspects of investing into Delaware Statutory Trusts: They are 1031 eligible upfront and upon exit, and investment amounts can be tailored to meet the exact financial requirements of the downleg of your exchange. DST investors purchase fractional shares of the trust and receive monthly or quarterly distributions, as applicable, according to their pro rata share of the trust.

Investing in a DST is another 1031 exchange strategy that could be beneficial for investors seeking reduced management duties, or for investors who have had problems identifying suitable replacement properties.

FAQs (Frequently Asked Questions)

Here are some commonly asked questions about 1031 exchanges:

How does the 45-day identification period work?

At midnight on the day your relinquished property closes, the clock begins ticking, and you have 45 days to formally identify a replacement property. You can find additional details on the 45-day identification period and three identification rules above in the section titled, “Understanding the Basics of 1031 Exchanges.”

Can I exchange my primary residence?

The answer here is no … and yes. You can’t directly exchange a primary residence because it’s held for personal use rather than an investment. However, if you rent the property out at fair market value for a minimum of two of the past five years, it may be eligible for 1031 exchange treatment.

What are the key risks of a 1031 exchange?

There are many – and many can be alleviated or possibly managed by assembling an experienced 1031 exchange team in advance. Execution risk, missed deadlines, choosing the wrong QI, illiquidity, misaligned property values, failed financing, and market downturns are all factors that can put your exchange at risk.

Can I do a 1031 exchange across state lines?

Absolutely. However, different states likely have different rules regarding taxation, capital gains, and the like. Your tax professional can help steer you in the right direction when exchanging from one state to another.

Key Takeaways and Summary of Benefits

Real estate investors typically complete 1031 exchanges in order to defer capital gains taxes, which are generated when investment properties sell for more than their adjusted cost basis.

In addition to tax deferral, there can be other advantages with this strategy. You’ll keep more of your investment capital to roll into another asset, which may allow you to purchase larger properties that may bring in higher monthly rental payments. You can divest properties that require active management for passive DST interests, freeing up time for other pursuits or investment opportunities. You can attempt to manage concentration and market risk by exchanging into different asset classes in different geographical regions, which also can enhance portfolio diversification.

Investment real estate also isn’t directly correlated to broader movements in public equities markets, which could provide a hedge against market downturns. It provides opportunities for asset appreciation, regular cash flow, and key tax deductions that can be used to offset ordinary income.

If you own an investment property and have decided it’s time to sell, but you don’t want to lose a hefty chunk of profit to taxes – which can be almost 35 percent of your sales proceeds – consider a 1031 exchange as an alternative to a straight sale. You can divest multiple properties that may be more management-intensive, such as apartments, townhomes and duplexes, for ones that are more suitable to your objectives, such as a self-storage facility or office building. The possibilities are nearly endless since you can 1031 exchange across state lines and into a huge variety of commercial real estate.

Lastly, it’s important to consider the estate planning implications of 1031 exchanges. Throughout your lifetime you can complete multiple 1031 exchanges and buy progressively higher-value properties, and when you bequeath these assets to your heirs they will benefit from a step-up in basis that has the potential to wipe out or significantly reduce all of your deferred tax liabilities.

Final thoughts on 1031 exchanges

As interest rates rose in 2022 and 2023, sales of investment properties slowed greatly, especially in multifamily and industrial properties, both of which had proved to be the most resilient asset classes of commercial real estate during the Covid-19 pandemic.

Property owners may feel the potential upside on their assets has plateaued, while the cost of expenses and capital continue to rise. Investors may find suitable 1031 exchange properties that haven’t been on the market in years. Property owners also may decide it’s time to shed active management duties altogether and exchange into Delaware Statutory Trusts, which could present more investment opportunities for 1031 exchange buyers.

While interest rates remain high, cash buyers are likely to have the strongest footing when it comes to acquiring replacement properties. Long-term owners who have realized significant asset appreciation may have the ability to pay in cash and find themselves in a better purchasing position than debt buyers who need to access traditional financing.

In the end, the viability of a 1031 exchange depends on your investment goals, financial strength, potential tax burden from selling an investment property, and a host of other factors. While we’ve tried to address as many of those factors as possible, each exchange scenario is unique to a particular investor. Engaging the appropriate professionals with extensive experience in the 1031 exchange process can help you strategize and create a winning exchange gameplan.