What is a 1031 Exchange?
Why do people use it? By deferring taxes, investors can keep more capital working in real estate, potentially compounding their wealth over time. For example, instead of losing 20-30% of your profit to taxes, you can reinvest the full amount into a larger or more profitable property. This can be repeated multiple times, and the tax liability is only realized when you eventually sell without exchanging—or, in some cases, it’s eliminated if the property passes to heirs under current estate tax rules.
There are strict rules to follow:
- Timeline: After selling the original property, you have 45 days to identify up to three potential replacement properties (or more under specific guidelines) and 180 days total to close on one or more of them.
- Qualified Intermediary: You can’t touch the sale proceeds directly; they must be held by a third-party intermediary who handles the transfer to the new property.
- Value and Debt: The replacement property must have equal or greater value and debt than the one sold, or you’ll owe taxes on any “boot” (cash or value not reinvested).
- Same Taxpayer: The name or entity on the title of the sold property must match the buyer of the new property.
DSTs, as mentioned earlier, tie in because they’re a popular choice for 1031 exchanges. Investors can roll proceeds from a sold property into fractional ownership of a DST’s portfolio, gaining passive income and diversification without managing the property themselves. However, 1031 exchanges aren’t a free lunch—deferred taxes will eventually come due unless strategically managed, and the process requires careful compliance to avoid IRS penalties. It’s a powerful tool for real estate investors looking to optimize their portfolio’s growth while keeping Uncle Sam at bay for a while.
We love helping investors take the next step. Please don’t hesitate to call us – we have 1031 Specialists ready to answer your questions just one phone call away at (949) 328-6744.