Estate planning is about more than just transferring wealth; it’s about preserving legacy, reducing tax friction, and how assets may align with long-term family objectives. For clients with investment real estate, 1031 Exchanges can be a component of strategies designed to align current real estate decisions with future estate planning goals.
As advisors guide clients through the complexities of estate design, understanding how
Section 1031 fits into multigenerational wealth conversations and can be an important part of the broader wealth conversation.
What Is a 1031 Exchange?
Section 1031
of the Internal Revenue Code allows real estate investors to defer recognition of capital gains taxes when they sell a property and reinvest the proceeds into another “like-kind” property. This can allow clients to reposition their portfolios—whether for income, diversification, or lifestyle—without triggering immediate tax consequences.
These exchanges can also support long-term legacy and estate goals when structured strategically.
- Step-Up in Basis Considerations
One of the notable multigenerational planning aspects of a 1031 Exchange is how it interacts with the step-up in basis at death. When a property held in a 1031 Exchange passes to heirs, its cost basis is “stepped up” to the fair market value on the date of death. This adjustment can eliminate unrealized capital gains for tax purposes, depending on applicable law at the time.
This means that while taxes on gains may be deferred during the investor's lifetime, the stepped-up basis can reduce or eliminate those gains for heirs under current tax rules—subject to future legislative changes.
- Consolidating or Diversifying the Estate with DSTs
Clients nearing retirement might consider using 1031 Exchanges to consolidate multiple active properties into passive structures like Delaware Statutory Trusts (DSTs). These structures can provide exposure to institutional real estate and distribute income, without the day-to-day responsibilities of property management.
DSTs also offer fractional ownership, which may simplify asset division among heirs and help facilitate estate administration. However, investors should consider the illiquidity and specific risks associated with DST investments.
- Tailoring Asset Profiles to Family Needs
1031 Exchanges allow clients to realign real estate holdings based on future family goals. For example:
- Swapping growth-oriented assets for income-generating properties to support a surviving spouse
- Transitioning from concentrated geographic exposure into diversified property sectors
- Replacing high-maintenance assets with low-friction vehicles better suited for heirs
These strategies can help align real estate assets with a family’s long-term planning preferences, though they should be assessed in the context of broader financial and estate considerations.
- Integrating with Trusts and Estate Structures
Properties acquired via 1031 Exchange can be held within revocable trusts, family limited partnerships (FLPs), or other estate structures, providing added control over distributions, asset protection, and generational planning. Advisors working alongside estate attorneys can help ensure the real estate strategy dovetails with the broader estate framework.
Understanding the Risks and Considerations of 1031 Exchanges
While 1031 Exchanges can provide meaningful tax deferral and estate planning benefits, they also carry certain risks and limitations that clients should understand before proceeding. Advisors play a key role in helping clients evaluate whether a 1031 strategy aligns with their broader financial and estate objectives.
Liquidity and Access Limitations
Properties acquired through a 1031 Exchange, particularly when structured via DSTs or other passive vehicles, may be illiquid. Investors should be aware that accessing principal or exiting these investments before a sale of the underlying property may not be possible—or may involve significant restrictions.
Loss of Basis Step-Up with Early Disposition
To benefit from the step-up in basis at death, clients must continue to hold the exchanged property until death. If the asset is sold during the investor’s lifetime, the previously deferred capital gains become taxable. This underscores the importance of long-term planning and aligning the investment horizon with estate goals.
Identification and Timing Constraints
1031 Exchanges require strict adherence to deadlines: the replacement property must be identified within 45 days and acquired within 180 days of the sale. These deadlines are inflexible, and failure to meet them can result in a taxable event. Advisors should ensure clients are prepared to act quickly and have contingency plans.
Like-Kind Property Requirements
Not all real estate qualifies. Clients cannot exchange into personal residences, properties held outside the U.S., or certain types of real estate entities. Advisors should confirm eligibility early in the planning process to avoid disqualification.
Market and Concentration Risk
Because 1031 strategies often involve reinvesting into specific types of real estate—sometimes in concentrated sectors or geographies—clients may take on concentrated market risk. Diversification strategies, where appropriate, should be considered.
Potential Legislative Changes
1031 Exchanges and the step-up in basis are features of current tax law, which may change. Clients considering long-term plans should be made aware that future legislation could alter the benefits or availability of these strategies.
Final Thoughts
1031 exchanges are more than a tax deferral tool. Use strategically, they are a dynamic planning instrument that can preserve wealth across generations. For advisors, understanding the intersection between real estate, tax planning, and estate transfer is essential to delivering comprehensive, multigenerational value.
By weaving 1031 strategies into legacy conversations, advisors help clients confidently do more than pass down assets.
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.
Article written by: Story Amplify. Story Amplify is a marketing agency that offers services such as copywriting across industries, including financial services, real estate investment services, and miscellaneous small businesses.
https://www.investopedia.com/terms/1/1031exchange.asp
https://www.irs.gov/publications/p559
https://www.inland-investments.com/education/1031-exchange-dsts
https://www.irs.gov/charities-non-profits/charitable-organizations/charitable-remainder-trusts
