A real estate rollover is a type of property exchange that allows the investor to roll their gains over into like-kind property. This transaction is called a 1031 exchange. Because gains from the relinquished property are rolled into the acquired property, taxes on those gains are deferred.
Deferred doesn't mean the gains have evaporated, and the investor won’t have to ever pay taxes on them. It means that until the investor liquidates the property, they can continue to defer taxes on gains. Down the road, the investor can utilize another 1031 exchange to acquire more like-kind property and keep deferring the original gains in the process.
A 1031 exchange tax deferment doesn’t mean the investor is dodging taxes or somehow getting away with not paying taxes. Once the property is liquidated, the IRS will come calling for their share of taxes due.
Using a 1031 exchange, real estate owners can reinvest their profits from the sale of income-producing properties into other similar income-producing properties while deferring the taxes.
In a way, the 1031 exchange tax deferment component is similar to that of the 401(k) tax deferment. Investors contribute to their 401(k) using tax-free dollars. It’s not until they begin taking distributions (i.e., liquidating the 401(k)) that they realize taxable gains. Just as a 401(k) allows investors to push their tax bill out by decades, so too does the 1031 exchange.
Some property owners choose to exit their actively-managed, direct real estate for a more passive form of real estate investment. This might be via a 1031 exchange into a DST. The DST removes the burden of having to manage property actively. At the same time, the investor can also defer taxes on any gains from the relinquished property.
