Should you do a 1031 exchange? Sometimes. But the tax savings shouldn’t be the only reason.
A 1031 exchange can be a powerful tax-deferral strategy for investors who want to remain invested in real estate. But for someone approaching retirement, the more important question may be what they want their capital to accomplish next.
If you’ve owned an investment property for decades and accumulated a substantial unrealized gain, selling can create a difficult choice. You can potentially defer the tax by exchanging into another property, or you can pay the tax, unlock the equity, and redeploy the remaining capital elsewhere.
Neither decision is automatically better. The right answer depends on your retirement income needs, liquidity, diversification, investment goals, tax situation, and whether you actually want to continue owning real estate.
What a 1031 Exchange Actually Does
A 1031 exchange lets you sell investment or business real estate and reinvest the proceeds into another qualifying property without recognizing the capital gain from the sale immediately. The critical word is immediately. The deferred gain doesn’t disappear. It carries forward in the form of a lower cost basis in the replacement property, meaning the tax will eventually come due when you sell in a taxable transaction, unless you exchange again, hold the property until death and receive a step-up in basis, or gift the property to charity.
The mechanics are specific. You can’t receive the sale proceeds yourself. The money must flow through a qualified intermediary who holds the funds between the sale and the purchase. From the date you close on the sale, you have 45 days to identify potential replacement properties in writing, and 180 days, or the due date of your tax return for that year including extensions, whichever comes first, to close on the purchase. Miss either deadline and the exchange fails, leaving you with a fully taxable transaction.
The like-kind requirement is broadly interpreted for real estate. Most U.S. investment or business real estate qualifies as like-kind to other U.S. investment or business real estate. An apartment building can exchange for raw land, a retail strip for a warehouse. The like-kind test is rarely the obstacle. The deadlines and the execution discipline typically are.
The Central Question Before Any Other
Before running the tax numbers, there’s a more fundamental question worth answering: would you buy the replacement property if there were no tax benefit?
If the answer is yes, a 1031 exchange deserves serious consideration. If the answer is no, or even probably not, the exchange is being driven by the tax bill rather than the investment decision. That’s the tax tail wagging the investment dog, and it deserves to be named for what it is.
A 1031 exchange doesn’t create wealth. It preserves more capital for continued investment in real estate. Whether that’s the right outcome depends entirely on whether real estate is still the best place for that capital at this stage of your life.
A Concrete Example
Suppose a retiree is two years from retirement with a $1.5 million investment property, an adjusted basis of $500,000, and a $150,000 remaining mortgage. They’ve managed the property for 20 years, it’s produced solid returns, but they’re tired of dealing with tenants and maintenance, and they’d rather have more flexibility heading into retirement.
Under Option A, they execute a 1031 exchange into a $1.5 million replacement property. They continue their real estate exposure, defer the tax, and maintain roughly the same management burden. Their capital remains concentrated in a single asset class, and their net worth is still largely illiquid.
Under Option B, they sell. The $1.4 million in net sale proceeds after paying off the mortgage are subject to capital gains tax. The gain of roughly $1 million breaks into a depreciation recapture component taxed at a maximum 25% federal rate, and an appreciation component taxed at long-term capital gains rates, typically 20% for higher earners plus the 3.8% Net Investment Income Tax where applicable, and Colorado’s 4.4% state rate. The actual tax bill depends on their specific income, filing status, capital losses, and other factors, but illustratively, a federal and state bill of $250,000 to $300,000 leaves roughly $1.1 million in net proceeds to redeploy. That $1.1 million, invested in a diversified portfolio, generates income, eliminates the management burden, increases liquidity, and doesn’t require another property decision.
Neither option is automatically better. What matters is which one better supports the retirement they want to live.
The Tax You’re Deferring Is More Manageable Than Most People Think
The 1031 exchange often feels like the only rational option because the tax bill seems catastrophic. Running the actual numbers usually changes the conversation.
Some of the gain attributable to depreciation deductions over the years of ownership may be treated as unrecaptured Section 1250 gain, taxed at a maximum federal rate of 25%. The remaining appreciation is generally taxed at long-term capital gains rates of 0%, 15%, or 20% depending on income. Higher earners may owe an additional 3.8% Net Investment Income Tax. Colorado adds 4.4% at the state level. The actual tax depends on the specific property, the investor’s income, filing status, capital losses, and other variables, which is why running the numbers with a tax professional before making any decision is essential.
The point isn’t that the tax is small. It’s that the after-tax proceeds from a sale are often a meaningful amount of capital that can be redeployed into a diversified, liquid portfolio suited to retirement rather than a concentrated, illiquid real estate position.
One additional wrinkle worth planning around: a large taxable gain in a single year can affect Medicare premiums through the IRMAA surcharge, which is based on a two-year income lookback. A sale at 63 can raise Medicare Part B and Part D premiums at 65. It can also affect the cost of Roth conversions in the same year, the taxation of Social Security, and the interaction with RMDs if those are approaching. These aren’t reasons to avoid a sale, but they’re reasons to model the timing carefully rather than making the decision in isolation.
The Retirement Question: What Does This Property Need to Do for You?
This is where the 1031 exchange conversation gets most useful for someone approaching retirement, and it’s where most generic 1031 articles fall short.
The relevant questions aren’t just about the tax. They’re about what role the property plays in the retirement plan and what role you want it to play.
How much retirement income does the property actually generate after expenses, vacancies, management fees, and capital costs? How much of your net worth does this single asset represent? Do you want to continue as a landlord at 70, 75, or 80, or does the management burden become a meaningful quality-of-life issue? What happens to your retirement income if the property sits vacant for six months? What happens if a major repair hits in the early years of retirement when the financial impact is hardest to absorb?
If the property generates meaningful income that’s genuinely passive and well-managed, it may deserve a place in a retirement income plan. But real estate is rarely as passive as it sounds, and a property that was worth managing during your working years may not be worth managing when you have other things you’d rather be doing.
This is something that comes up consistently in practice. When people are working, the burden of a rental property is manageable because it fits into a broader structure of obligations and routines. Retirement changes that. A call at 9pm about a broken furnace, a tenant dispute, a vacancy that needs to be filled, a roof that needs replacing at the worst possible time, these aren’t abstract risks. They’re the actual experience of owning investment real estate, and for many retirees, the income the property produces simply isn’t worth the stress and mental real estate it consumes. Retirement is supposed to be the chapter where you stop being on call for things you don’t want to deal with. A rental property can quietly become the thing that prevents that.
The question worth sitting with isn’t just whether the property generates income. It’s whether you actually want to own it at 70 and 75, and whether the person you’re most likely to become in retirement is someone who wants to be a landlord. Many people who answer honestly say no, and the 1031 exchange locks them into exactly that role for another decade or more.
The step-up in cost basis at death is also worth understanding here. If you hold appreciated real estate until death, your heirs generally receive a step-up to fair market value, which can eliminate decades of deferred gains. For a retiree with estate planning goals and heirs who want the property, a hold-and-exchange strategy can make strong sense. For a retiree who plans to spend the proceeds to fund retirement, that estate planning benefit is irrelevant, and the analysis shifts accordingly.
When a 1031 Exchange Makes Sense
There are genuinely good reasons to execute a 1031 exchange, and the best ones are rooted in investment logic rather than tax avoidance.
If you want to stay invested in real estate and have a clear property you’d buy on its own merits, an exchange makes sense. You might be upgrading to a higher-quality asset with better tenants, consolidating several smaller properties into one that’s easier to manage, moving your exposure to a stronger market, or improving cash flow with a lower-maintenance property. In all of these situations, the tax deferral is a benefit on top of a move you’d want to make anyway. That’s the right way to use a 1031 exchange.
When It Doesn’t
If you’re tired of managing the property and the only thing keeping you invested in real estate is the deferred tax bill, the exchange is a tax decision masquerading as an investment decision.
Real estate ownership is also a form of concentration. A single property or collection of properties representing a large share of someone’s net worth carries the same risks as any concentrated position: illiquidity, single-market exposure, and the ongoing demands of active management. Deferring taxes by rolling into another concentrated real estate position doesn’t solve the underlying problem. A well-diversified portfolio that can be drawn down systematically to fund retirement spending may serve a retiree better than another decade of property management, even if the exchange would preserve more nominal capital.
What About DSTs and REITs?
Investors who want to exit active real estate management but still execute a 1031 exchange sometimes look at Delaware Statutory Trusts, or DSTs, as replacement property. A DST is a professionally managed real estate structure that can qualify as 1031 replacement property, allowing you to exchange into a passive vehicle without taking on another landlord role.
DSTs are an investment structure, not just a tax strategy, and the two shouldn’t be conflated. The investor is exchanging one form of real estate exposure for another, not transforming the investment into a liquid diversified portfolio. The DST structure comes with meaningful constraints: the trustee generally can’t renegotiate leases, raise additional capital, or significantly alter the investment. Liquidity is limited by the trust structure rather than by your timeline. Fees can be significant. Sponsor risk is real. The suitability of any specific DST depends on the underlying properties, the sponsor’s track record, the fee structure, and whether the investor’s circumstances match the trust’s investment horizon.
REIT shares are a separate matter. Publicly traded REITs are liquid, professionally managed, and diversified, but they’re securities rather than direct real estate and generally don’t qualify as 1031 replacement property. Non-traded REITs have been marketed to real estate investors in this context, but they carry meaningful risks including illiquidity for years or decades, distribution structures that can return your own capital rather than investment income, and up-front fees that can be substantial. Caution is warranted.
Five Questions to Ask Before Executing a 1031 Exchange
These are the questions we work through with any client considering an exchange.
Would I buy the replacement property if there were no tax benefit? If the answer is anything other than a clear yes, the exchange is being driven by the tax rather than the investment. That’s the clearest possible warning sign.
How much of my net worth will remain tied up in real estate? Concentration in a single asset class creates risk. If the exchange keeps most of your wealth in a single property or asset type, the diversification problem persists.
Do I actually want to own and manage real estate throughout retirement? The management burden that felt manageable at 52 may feel different at 72. Being honest about this before executing an exchange is better than discovering it three years into the replacement property.
What does my retirement plan look like if I sell and invest the net proceeds? Running the comparison between exchanging and selling in the context of a full retirement income plan is the only way to make the decision on its actual merits rather than on the tax bill alone.
What is the long-term tax and estate-planning benefit of holding the property? For investors with strong estate planning goals and heirs who want the real estate, the hold-and-exchange strategy can be genuinely powerful. For investors who plan to spend the proceeds in retirement, the calculus is different.
How We Think About This at Inclinevest
The right decision isn’t the one that produces the lowest tax bill today. It’s the one that best supports your retirement income, liquidity, diversification, tax strategy, and estate plan over the next 10 to 20 years.
Gabriel Motta, CFP®, is a retirement financial advisor in Denver, Colorado, working with pre-retirees and retirees in the five to fifteen years before and after retirement, when decisions about concentrated assets, tax timing, and portfolio structure have the most lasting consequences. If you’re considering selling appreciated investment real estate before or during retirement, Inclinevest can help you compare the 1031 exchange against selling, paying the tax, and redeploying the proceeds as part of a broader retirement plan. We’d be glad to start that conversation. You can also review our services and fees.
Frequently Asked Questions
Is a 1031 exchange tax-free? No. It defers the capital gains tax, it doesn’t eliminate it. The replacement property carries over the lower cost basis from the original, so the deferred gain remains until you sell in a taxable transaction or the property passes to heirs with a step-up in basis.
What are the deadlines for a 1031 exchange? You have 45 days from the close of the sale to identify replacement property in writing, and 180 days, or the due date of your federal tax return including extensions, whichever comes first, to close on the purchase. These deadlines are strict and missing either one generally results in a failed exchange.
How much tax will I owe if I just sell? It depends on your basis, income, filing status, and other factors. A portion of the gain may be subject to a maximum 25% federal rate as unrecaptured Section 1250 gain, with remaining appreciation taxed at long-term capital gains rates. Higher earners may owe an additional 3.8% Net Investment Income Tax. Colorado adds 4.4%. Running the actual numbers with a tax professional before deciding is essential.
Can I use a 1031 exchange to buy REIT shares? Generally no. REIT shares are securities rather than direct real estate. Certain Delaware Statutory Trust interests can qualify as 1031 replacement property, but they come with structural limitations, liquidity constraints, and fees that deserve careful review.
What happens to the deferred gain if I hold the property until death? Your heirs generally receive a step-up in cost basis to the property’s fair market value at the date of death, which can effectively eliminate decades of deferred gains. This is one of the more powerful aspects of a hold-and-exchange strategy for investors with estate planning goals.
Should I do a 1031 exchange or pay the tax? It depends on your goals, your retirement income needs, and what you’d do with the proceeds. The question worth asking first: would you buy the replacement property if there were no tax benefit? If yes, an exchange deserves serious consideration. If not, the exchange is being driven by the tax, not the investment.
About the Author
Gabriel Motta, CFP®, MBA, is the founder and principal of Inclinevest LLC, a fee-only fiduciary retirement financial advisor and financial planner based in Greenwood Village, Colorado. He works with pre-retirees and retirees throughout south Denver, across Colorado, and nationally, including clients in Highlands Ranch, Centennial, Lone Tree, Aurora, Parker, Castle Rock, and Littleton. As a retirement planner and wealth manager, Gabriel helps clients navigate retirement income planning, Social Security strategy, tax-efficient withdrawals, and equity compensation. Gabriel is a NAPFA and XY Planning Network member. Learn more at inclinevest.com or schedule a conversation.
Sources
- IRS, “Like-Kind Exchanges Under IRC Section 1031” — https://www.irs.gov/pub/irs-news/fs-08-18.pdf
- IRS, “Instructions for Form 8824 (Like-Kind Exchanges)” — https://www.irs.gov/instructions/i8824
- IRS, “Topic No. 409: Capital Gains and Losses” — https://www.irs.gov/taxtopics/tc409
- IRS, “Topic No. 559: Net Investment Income Tax” — https://www.irs.gov/taxtopics/tc559
- IRS, “Publication 544: Sales and Other Dispositions of Assets” — https://www.irs.gov/publications/p544
- IRS, “Instructions for Schedule D (Form 1041): Unrecaptured Section 1250 Gain” — https://www.irs.gov/instructions/i1041sd
- CMS, “2026 Medicare Parts B Premiums and Deductibles” — https://www.cms.gov/newsroom/fact-sheets/2026-medicare-parts-b-premiums-deductibles
This article is for general informational and educational purposes only. It isn’t personalized investment, tax, or legal advice, and it shouldn’t be relied on as a substitute for guidance specific to your situation. Tax rates, thresholds, and rules described here reflect current federal and Colorado state law, which is subject to change, and tax outcomes depend on individual circumstances. Inclinevest LLC is a registered investment adviser. Registration doesn’t imply any level of skill or training. Please consult a qualified tax professional and financial advisor before making decisions about your own circumstances.
