Investment property owners who plan their estates for the long term often ask this question: Can a 1031 Exchange be used to fund a life insurance policy?
The short answer is no — but there’s a longer, more strategic answer worth understanding.
A 1031 Exchange cannot be used to buy life insurance directly, but there are ways to link real estate and tax deferral with life insurance in a coordinated wealth plan. Let’s go over the rules and explore how savvy investors use both tools together.
What Is a 1031 Exchange?
A 1031 Exchange is a mechanism that allows real estate investors to defer capital gains taxes when they exchange an investment property and reinvest the proceeds into another similar property. Eligible properties include:
- Rental homes
- Commercial buildings
- Land held for investment
- Delaware Statutory Trusts (DSTs)
Life insurance, however, is not considered “like-kind” real estate under the IRS rules. This means you cannot sell a property and use the proceeds of a 1031 Exchange to purchase a life insurance policy directly without paying capital gains taxes.
Can Life Insurance Play a Role?
Yes — just not directly through the 1031 Exchange itself. Many real estate investors use a two-step approach:
- Complete a 1031 Exchange into a passive real estate investment (like a DST).
- Use income from the replacement property (e.g., monthly cash flow from the DST) to pay for a life insurance policy.
This method allows you to defer taxes, generate passive income, and leverage that income to support estate planning, legacy protection, or tax-free retirement income via life insurance.
Why Combine DSTs and Life Insurance?
This strategy appeals to investors who want to:
- Transition out of active property management.
- Preserve wealth through tax deferral.
- Provide structured benefits to heirs through the use of life insurance and estate planning tools.
- Fund permanent life insurance with real estate income.
Some high-net-worth investors even pair this strategy with Irrevocable Life Insurance Trusts (ILITs) or other estate planning vehicles with the goal of mitigating potential estate tax exposure.
This strategy involves complex tax, legal, and insurance considerations. DST investments are illiquid and may involve the risk of loss, while life insurance policies may lapse if not properly funded. Neither tax deferral nor estate tax minimization is guaranteed, and outcomes depend on individual circumstances and regulatory factors.
Real Example
You have $1 million of equity in a rental property with a $400,000 capital gain. Selling the property outright could result in over $100,000 in taxes.
Instead, you complete a 1031 Exchange into a DST that is projected to generate approximately $40,000/year in passive income. You then use a portion of that cash flow to pay for a whole life or indexed universal life insurance policy to potentially create a tax-free death benefit for your heirs.
Work With the Right Team
Real estate, tax strategies, and life insurance planning require careful coordination. Your CPA, estate attorney, and insurance advisor should be aligned — and so should your real estate partner.
At Realized, we help property owners evaluate tax-efficient exit strategies using our Investment Property Wealth Management approach. Whether you want income, legacy, or liquidity, we can help you structure a 1031 Exchange that may be considered part of your overall financial strategy.
Curious whether a DST and life insurance approach may align with your goals?
Let’s discuss how a DST + life insurance strategy might work for your situation.
The tax and estate planning information offered by the advisor is general in nature. It is provided for informational purposes only and should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.
