Latest / The High Net Worth Podcast with Fexingo: Wealth Management, Tax Strategy, and Affluent Finance / How Ultra-Wealthy Families Use 1031 Exchanges for Real Estate Tax Deferral
Transcript
- Lucas: If you own an investment property that has doubled in value, selling it triggers a capital gains tax bill that can easily run into seven or eight figures. But there is a legal way to defer that tax indefinitely—Section 1031 of the Internal Revenue Code. Luna: The like-kind exchange. I think a lot of people have heard the term but have no idea how it actually works. Lucas: Exactly. And it is surprisingly mechanical. You sell a property, you have 45 days to identify potential replacement properties, and then 180 days total to close on one. As long as the new property is of 'like kind'—which for real estate basically means any real estate held for investment or business use—you defer the gain. Luna: So you could swap a strip mall in Ohio for a ranch in Montana and still qualify? Lucas: Correct. The IRS defines 'like kind' very broadly for real estate. The key is that you cannot take cash out. Any cash you receive—they call it 'boot'—is immediately taxable. Luna: And you have to use a qualified intermediary. You cannot touch the proceeds yourself. Lucas: Right. The intermediary holds the sale proceeds in a separate account and then transfers them directly to the seller of the replacement property. If the money hits your bank account even for a day, the exchange is disqualified. Luna: I recently read about a family office that used a 1031 to roll out of a $45 million apartment complex and into a portfolio of net-leased industrial properties. They deferred about $9 million in taxes. Lucas: That is a textbook move. Apartments are management-intensive. Net-leased industrial—where the tenant pays taxes, insurance, and maintenance—is essentially a bond-like return with zero landlord headaches. They swapped active management for passive income and kicked the tax can down the road. Luna: And they can keep doing it. There is no limit on how many times you can use a 1031 exchange. Lucas: No limit. You can defer indefinitely. And if you hold the property until death, your heirs get a step-up in basis, meaning the capital gains tax disappears entirely. Luna: That is the real endgame for a lot of wealthy families—permanent deferral through death. Lucas: Exactly. But there are pitfalls. The 45-day identification window is rigid. You cannot extend it. And you have to identify the properties in writing, signed by you and delivered to the intermediary. Luna: So if you sell in a hot market and cannot find a suitable replacement, you are stuck paying the tax anyway. Lucas: That is the biggest risk. We saw that in 2021 and 2022 when inventory was incredibly tight. A lot of exchangers ended up overpaying for properties just to meet the deadline. Luna: And you also have to reinvest all the equity. If you sell a $10 million property with $4 million in debt, you need to buy a property worth at least $10 million and put at least $4 million in new debt. Lucas: Right. The 'equal or greater' rule. If you come in with less debt, the difference is treated as boot. So you have to maintain or increase your leverage. Luna: Which is harder in a rising rate environment. Lucas: Absolutely. Today, July 2026, borrowing costs are still elevated compared to the ultra-low rate era. That makes the math trickier. But for families with significant equity and a long time horizon, 1031 exchanges remain one of the most powerful tools in the tax code. Luna: Let's talk about what happens after you do the exchange. You have a new property with a lower tax basis. That means higher depreciation recapture down the road. Lucas: That's a great point. The deferred gain is not forgiven—it is carried forward into the new property. So when you eventually sell without another exchange, you pay tax on the original gain plus any new appreciation. But as we said, if you hold to death, that gain gets stepped up. Luna: One thing that changed with the Tax Cuts and Jobs Act of 2017: personal property no longer qualifies. So you cannot do a 1031 on aircraft, artwork, or farm equipment anymore. Lucas: Right. That was a big shift. Previously you could exchange a plane for a plane, or even a plane for a building. Now it is strictly real estate. But real estate is still the most common use case by far. Luna: And we have seen some creative structures. Tenants-in-common interests, Delaware statutory trusts, even some REITs structured as 1031 replacement properties. Lucas: Those are popular for investors who want to diversify into multiple properties without having to identify and close on each one individually. But they come with higher fees and less control. Luna: Yeah, the DST market has grown a lot. It allows smaller investors to pool money and still get the tax deferral. Lucas: Let's step back for a second. If today's conversation helped you think about real estate or tax strategy a little differently, we do have a small ask. Listener support is what keeps this show ad-free and independent. If it was worth a coffee to you, that link is buy me a coffee dot com slash fexingo. No pressure, just a genuine thank you if you choose to. Luna: Completely agree. It means a lot that people find value in what we do here. Lucas: Alright, back to the mechanics. One of the lesser-known strategies is the 'reverse 1031 exchange' where you buy the replacement property first before selling your original property. Luna: That is allowed? I thought you had to sell first. Lucas: The IRS actually permits it, but only through a qualified intermediary using an 'exchange accommodation titleholder' who holds title to the replacement property until your original property sells. It is more complex and requires more capital upfront, but it solves the 45-day identification problem if you already have a property in mind. Luna: So you essentially park the new property with a third party until the sale closes. Lucas: Exactly. And you have 180 days from the purchase of the replacement property to sell your original one. It is a powerful tool in a fast-moving market. Luna: I want to touch on state taxes. Some states do not conform to federal 1031 rules. Lucas: That is an important nuance. California, for example, does not fully conform. You still get the deferral for federal purposes, but California may require you to pay state capital gains tax on the sale unless you buy replacement property in California. So wealthy families with properties in high-tax states need to plan carefully. Luna: And there is also the issue of like-kind for international properties. Can you exchange a US property for one in another country? Lucas: No. The IRS requires both properties to be located within the United States. So no cross-border 1031 exchanges. Luna: That is a hard line. But within the US, the flexibility is enormous. Lucas: It is. And that is why 1031 exchanges remain a cornerstone of wealth preservation for real estate investors. The combination of indefinite deferral, step-up in basis at death, and the ability to upgrade or rebalance a portfolio tax-free is incredibly powerful. Luna: So if you are a family with significant real estate holdings, this is a tool you absolutely need to understand. Lucas: Absolutely. And with the right planning, it can save millions over a lifetime.