How 1031 Exchanges Help Real Estate Investors Grow and Transfer Wealth

Article | June 27, 2025

Authored by Your Firm LLC

The most successful real estate investors share two traits: they know how to keep capital working, and they plan far beyond the next transaction. A properly executed Section 1031 like–kind exchange lets you do both. By deferring capital-gains taxes on appreciated property, you free up equity to acquire larger or better-performing assets today while positioning your portfolio for a tax-efficient transfer to your children tomorrow. The result is a powerful combination of growth, preservation, and legacy planning.

What Is a 1031 Exchange?

Section 1031 of the Internal Revenue Code allows investors to defer recognition of gain when they exchange real property held for investment or business use for another like-kind property of equal or greater value. Although often called “tax-free,” the gain is deferred, not forgiven—the built-in gain carries forward into the replacement property and becomes taxable when that asset is eventually sold outside another exchange.

Core Requirements

• Like-kind real property. Almost any U.S. real estate held for investment can be exchanged for any other domestic investment real estate—raw land for apartments, a single-tenant retail building for an industrial warehouse, etc.
• Use of a qualified intermediary (QI). To prevent “constructive receipt” of sale proceeds, funds must flow through an independent QI who holds the cash and acquires the replacement property on your behalf.
• Critical deadlines. You have 45 days from the sale of the relinquished property to identify replacement candidate(s) and 180 days from the sale date (or your tax-return due date, if earlier) to close on the purchase.

Why 1031 Exchanges Accelerate Portfolio Growth

1. Unlock trapped equity. Selling a highly appreciated asset outside an exchange can trigger substantial federal and state capital-gains tax, net investment income tax, and depreciation recapture. A 1031 exchange keeps that money in play, giving you more buying power.
2. Leverage into larger or multiple properties. Investors frequently exchange a single, smaller property for several higher-yielding assets—or consolidate multiple units into one institutional-grade asset that is easier to manage. Either way, the deferred tax dollars act like an interest-free loan from the government.
3. Diversify geography and asset class. Because “like-kind” is broadly defined, you can reposition your holdings into different markets or sectors (for example, shifting from local retail to out-of-state multifamily) while still deferring tax.
4. Improve cash flow and depreciation schedules. Newer properties often provide better tenants and higher rents. They also reset depreciation on improvements, creating additional annual deductions that shelter income.

Estate Planning Benefits: Turning Tax Deferral into Tax Elimination

Deferred gain does not have to remain an eventual tax liability. With careful coordination between your real-estate strategy and your estate plan, a 1031 exchange can become a cornerstone of multigenerational wealth transfer.

Step-Up in Basis at Death

When you pass away, the fair-market value of your real property becomes the new tax basis for your heirs. The deferred gain from prior 1031 exchanges effectively disappears, eliminating capital-gains tax entirely. Your children can choose to:

• Sell immediately with little or no taxable gain, converting real estate equity into liquid assets for diversification.
• Continue to hold and depreciate the property from the stepped-up basis, creating fresh deductions against rental income.

Gift and Estate Tax Efficiency

Because a 1031 exchange promotes continued growth of your portfolio, you may face future estate-tax exposure. Proper structuring—such as transferring fractional interests into family limited partnerships (FLPs) or irrevocable trusts—can reduce the taxable value of your estate while keeping management control in your hands. Coupled with valuation discounts and the lifetime gift and estate-tax exemption, this approach can move significant wealth to the next generation at a reduced transfer-tax cost.

Income for Multiple Generations

Cash-flowing replacement properties can fund your retirement and, later, provide ongoing income to your heirs. Pairing a 1031 exchange with estate-planning vehicles—such as qualified personal residence trusts (QPRTs), charitable remainder trusts (CRTs), or generation-skipping trusts—can tailor distributions, creditor protection, and tax outcomes to each beneficiary’s needs.

Illustrative Case Study

Sophia purchased a small office condo for $400,000 in 2010. Today it is worth $900,000 with $200,000 of accumulated depreciation. If she sells outright, she faces approximately $330,000 in combined federal and state taxes (capital gains, NIIT, and depreciation recapture), leaving roughly $570,000 to reinvest.

Instead, Sophia executes a 1031 exchange. Working with a qualified intermediary, she sells the condo and acquires a $1.6 million triple-net leased retail property. Because she rolled her full equity plus modest additional financing into the new asset, she pays no current tax.

The retail property generates stronger cash flow and minimal management responsibilities. When Sophia passes, her two children inherit the property at its then-current fair-market value—say $2 million—and owe no capital-gains tax on prior appreciation. They can keep the property for income, conduct another 1031 exchange, or sell tax-free and diversify.

Best Practices for a Successful 1031 Strategy

• Plan early. Identify goals—growth, consolidation, geographic move, estate considerations—before listing the relinquished property. Rushed decisions often lead to suboptimal replacement choices or identification-period stress.
• Assemble the right team. Your CPA, real-estate attorney, and qualified intermediary must work in concert. MBN & Company coordinates tax modeling, deadline management, and entity structuring while your intermediary handles escrowed funds and documentation.
• Understand boot. Cash or non-like-kind property received (boot) is taxable. To avoid boot, match or exceed both the fair-market value and the debt level of the relinquished property in the replacement property.
• Mind state conformity. Most states follow federal 1031 rules, but a few impose additional withholding or decoupling requirements. We review each transaction for multistate implications.
• Integrate with your estate plan. Update wills, trusts, and beneficiary designations after each major exchange to ensure the stepped-up basis and future income align with your legacy objectives.

Common Pitfalls to Avoid

1. Missing deadlines. The IRS grants no extensions for the 45-day identification or 180-day closing periods except in federally declared disasters.
2. Using related parties. Buying from or selling to certain related parties can disqualify the exchange or require a two-year holding period. Always confirm relationships with your advisor.
3. Poor record-keeping. Each exchange must be reported on Form 8824 with basis calculations that carry forward. Incomplete documentation can trigger audits and unexpected tax.
4. Neglecting depreciation recapture. Even though depreciation recapture is deferred, it doesn’t disappear until basis steps up. Keep a schedule to understand future exposure.

Integrating 1031 Exchanges with Broader Wealth Strategies

At MBN & Company, we view each exchange as one component of an integrated financial plan. Consider pairing your 1031 strategy with the following:

• Cost segregation studies. Accelerate depreciation on new acquisitions to offset rental income, improving after-tax cash flow.
• Qualified Opportunity Zones (QOZs). For gains that cannot be exchanged (e.g., from the stock market), QOZ investments may offer alternate deferral and potential exclusion benefits.
• Charitable planning. Combine an exchange with a CRT to defer gain, receive a charitable deduction, and provide lifetime income—while ultimately supporting a favored cause.
• Succession planning for active real-estate businesses. If your portfolio operates through partnerships or S corporations, ensure entity agreements and buy-sell provisions accommodate future exchanges and transfers.

Key Takeaways

• A 1031 exchange defers capital-gains and depreciation-recapture taxes, maximizing reinvestable equity.
• The deferral can become permanent through the basis step-up at death, making 1031 exchanges a cornerstone of generational wealth transfer.
• Strict rules on timing, like-kind property, and the use of a qualified intermediary demand expert guidance.
• Integrating 1031 exchanges with estate, gift, and income-tax planning unlocks compounding benefits for both you and your heirs.

Next Steps

Whether you are eyeing your first exchange or managing a portfolio of properties, proactive planning is essential. Our real-estate tax specialists can:

• Model projected tax savings and cash-flow impacts of potential exchanges.
• Coordinate with your brokers and qualified intermediary to meet identification and closing deadlines.
• Design estate-planning vehicles that align real-estate holdings with your family’s long-term goals.
• Guide ongoing compliance, including Form 8824 preparation and depreciation optimization.

Ready to turn appreciated property into a lasting legacy? Contact MBN & Company today to schedule a consultation and explore how a 1031 exchange strategy can accelerate growth and secure generational wealth for your family.

Disclaimer: This article provides general information and should not be construed as tax, legal, or investment advice. Every transaction is unique; consult your professional advisors before acting.