Investors May be Overpaying for Replacement Property in §1031 Exchanges

There are opin­ions among indus­try experts that investors uti­liz­ing a §1031 exchange may be over­pay­ing for the replace­ment prop­er­ty. These esti­mates range between 10% to 30%. We have writ­ten over the years that we believe this occurs almost 18% of the time.

April 2, 2025

By Al DiNi­co­la, AIF®
1031 Tax Deferred Exchange Spe­cial­ist & DST Advisor/Specialist
NAMCOA® — Naples Asset Man­age­ment Com­pa­ny®, LLC
Secu­ri­ties offered through MSC-BD, LLC, Mem­ber of FINRA/SIPC

There are many rea­sons why this has occurred and may con­tin­ue to occur.  Investors need to under­stand the rea­sons and poten­tial­ly the ratio­nale.

Let’s take a look at why §1031 tax-deferred investors often over­pay for replace­ment prop­er­ty. There may be sev­er­al key rea­sons.

1. Time Pres­sure – The IRS requires investors to iden­ti­fy a replace­ment prop­er­ty with­in 45 days and close with­in 180 days. This short time­line can force investors to make rushed deci­sions, some­times lead­ing to over­pay­ing to avoid tax­es.
   1. Investors may not plan well on arrang­ing poten­tial replace­ment prop­er­ties.
   2. Investors who need to replace debt may run out of time in the appli­ca­tion and accep­tance for the recourse loan.
2. Lim­it­ed Inven­to­ry – If the real estate mar­ket is tight, investors may have few­er options and feel pres­sured to pay more than they nor­mal­ly would to secure a prop­er­ty with­in the dead­line.
   1. Investors who want to change asset class may not be equipped with the prop­er due dili­gence to iden­ti­fy a dif­fer­ent asset class than their cur­rent prop­er­ty.
3. Tax Avoid­ance Focus – The pri­ma­ry moti­va­tion is often to defer cap­i­tal gains tax­es, rather than secur­ing the best invest­ment. Investors may pri­or­i­tize find­ing any qual­i­fy­ing prop­er­ty over ensur­ing they’re get­ting a good deal.
   1. Investors may use a sim­ple excel spread sheet to deter­mine the amount of cap­i­tal gains tax­es they want to avoid and ratio­nal­ize pay­ing what­ev­er price.
4. Sell­er Lever­age – Sell­ers and bro­kers know that §1031 exchange buy­ers are on a strict time­line, which can lead to high­er ask­ing prices since they rec­og­nize the urgency of the sit­u­a­tion.
   1. When a buy­er dis­clos­es their inten­tions of uti­liz­ing a tax deferred exchange the oppos­ing group (sell­ers and bro­kers) may be less inclined to nego­ti­ate. They fig­ure the investor needs to use all the cash.
5. Emo­tion­al Deci­sion-Mak­ing – Investors some­times over­es­ti­mate the ben­e­fits of tax defer­ral and over­look the impor­tance of prop­er­ty §, lead­ing to over­pay­ment.
6. Lack of Prop­er Due Dili­gence – Rushed pur­chas­es mean investors may not have time to nego­ti­ate effec­tive­ly, con­duct thor­ough mar­ket research, or find bet­ter financ­ing options.
7. Com­pet­ing with Insti­tu­tion­al Buy­ers – In com­pet­i­tive mar­kets, 1031 investors may find them­selves bid­ding against insti­tu­tion­al investors with greater resources, dri­ving up prices.

Here are sev­er­al strate­gies to help avoid over­pay­ing when exe­cut­ing a 1031 tax-deferred exchange:

1. Start the Process Ear­ly

• Begin research­ing poten­tial replace­ment prop­er­ties before sell­ing your cur­rent prop­er­ty.
• Engage with bro­kers, lenders, and prop­er­ty man­agers ear­ly to under­stand mar­ket con­di­tions.
• Even when you start the process ear­ly there is no guar­an­tee. We have tak­en calls from investors who have start­ed pri­or to the clos­ing on the relin­quished prop­er­ty to be fac­ing less than a week to locate replace­ment prop­er­ties. (A poten­tial rea­son to have a Delaware Statu­to­ry Trust aka DST as a back­up).

2. Con­sid­er a Reverse 1031 Exchange

• If finan­cial­ly fea­si­ble, pur­chase your replace­ment prop­er­ty before sell­ing your exist­ing one.
• This removes the time pres­sure and allows for a more strate­gic deci­sion.
• This is not always pos­si­ble since the investor needs access to oth­er cash and an arrange­ment with the QI. This would require an Exchange Accom­mo­da­tion Title­hold­er (EAT).

3. Expand Your Search Cri­te­ria

• Don’t lim­it your­self to prop­er­ties in the same area—look at dif­fer­ent mar­kets where prices may be more favor­able.
• Con­sid­er dif­fer­ent asset class­es (e.g., mul­ti­fam­i­ly, indus­tri­al, or self-stor­age) to find bet­ter deals.
• If you are replac­ing a tra­di­tion­al real estate invest­ment this mya be more com­pli­cat­ed since real estate bro­kers may have exper­tise in cer­tain areas.
• Rep­re­sen­ta­tives who work with DSTs are not lim­it­ed to one loca­tion in the coun­try and have access to assets all over the USA. We work with all the major DST spon­sors pro­vid­ing geo­graph­ic diver­si­fi­ca­tion.

4. Work with an Expe­ri­enced 1031 Exchange Advi­sor

• A qual­i­fied inter­me­di­ary (QI) can guide you through the process and help struc­ture a delayed, reverse, or improve­ment exchange to max­i­mize val­ue.
• A skilled real estate bro­ker with expe­ri­ence in 1031 exchanges can help iden­ti­fy under­val­ued prop­er­ties.
• Accred­it­ed investors who want access to DSTs will need a spe­cial­ist with the prop­er secu­ri­ties licens­es. Typ­i­cal­ly, real estate bro­kers do not have the addi­tion­al qual­i­fi­ca­tions.

5. Nego­ti­ate Aggres­sive­ly

• Just because you’re on a dead­line doesn’t mean you have to accept the first price.
• Use mar­ket comps and prop­er­ty per­for­mance met­rics (cap rate, cash flow) to jus­ti­fy a low­er offer.
• We have writ­ten about cap rates in two pre­vi­ous arti­cles.  Click here to access.

6. Eval­u­ate Prop­er­ty Fun­da­men­tals, Not Just Tax Ben­e­fits

• Ensure the replace­ment prop­er­ty has strong cash flow, appre­ci­a­tion poten­tial, and low main­te­nance costs.
• Avoid “tro­phy” prop­er­ties with inflat­ed prices that don’t jus­ti­fy their income poten­tial.

7. Con­sid­er a Delaware Statu­to­ry Trust (DST) as a Back­up

• A DST allows mul­ti­ple investors to own frac­tion­al inter­ests in insti­tu­tion­al-qual­i­ty prop­er­ties.
• If you’re run­ning out of time and can’t find a good deal, invest­ing in a DST can be a safer alter­na­tive.
• DSTs also may be a total back up solu­tion to the replace­ment prop­er­ty. Espe­cial­ly if there is a need to replace debt. DST by design have non-recourse debt. Investors do not need to apply for the replace­ment loan (assign­ment) nor does the loan show up on any cred­it report.
• DSTs may also be used for “boot”.  The boot may be the remain­ing cash left over after nego­ti­at­ing a great price on the pri­ma­ry replace­ment prop­er­ty.

8. Have Mul­ti­ple Back­up Prop­er­ties Iden­ti­fied

• IRS rules allow you to iden­ti­fy up to three prop­er­ties or use the 200% rule (iden­ti­fy­ing prop­er­ties that total up to 200% of the relin­quished property’s val­ue).
• This ensures you have alter­na­tives in case a deal falls through.
• We assist investors in under­stand­ing and, some­times, assist­ing investors with com­plet­ing their 45-day noti­fi­ca­tion list to be turned in to the QI.  Often the list changes between day 1 and day 45.
• In larg­er exchanges we have assist­ed investors with iden­ti­fy­ing mul­ti­ple prop­er­ties. In one of the larg­er exchanges, we iden­ti­fied 13 dif­fer­ent prop­er­ties, and the investors closed on sev­en of those prop­er­ties. This pro­vid­ed a diver­si­fied port­fo­lio for the investor.

9. Avoid High-Pres­sure Sales Tac­tics

• Some bro­kers or sell­ers push over­priced prop­er­ties on 1031 buy­ers know­ing they are under time con­straints.
• If some­thing feels rushed or over­priced, step back and reeval­u­ate.

Final Thoughts

We inter­face with many investors who are already on their way to com­plet­ing their exchange and uti­lize our exper­tise as a sound­ing board. We wel­come the oppor­tu­ni­ty to dis­cuss cur­rent and future exchanges. We may have a few addi­tion­al strate­gies and solu­tions to avoid over­pay­ing for the replace­ment prop­er­ty.  This may add extra val­ue to the invest­ment and open up a new exit strat­e­gy. We have over 80 years of expe­ri­ence in the real estate and invest­ment advi­so­ry. We also review, on a week­ly basis, DST offer­ings so we can quick­ly respond when investors are faced with the clock run­ning out on their 45-day iden­ti­fi­ca­tion peri­od.

NAMCOA® is a SEC reg­is­tered invest­ment advi­so­ry firm that pro­vides com­pre­hen­sive port­fo­lio man­age­ment, finan­cial plan­ning, and fidu­cia­ry deci­sion-mak­ing ser­vices on behalf of retire­ment plan spon­sors. Our Dif­fer­ence is sum­ma­rized by our fidu­cia­ry approach which enables us to bet­ter meet port­fo­lio and retire­ment plan objec­tives, result­ing in stronger risk adjust­ed returns for investors and peace of mind for Clients. We also focus on alter­na­tive real estate invest­ment. Many real estate investors are seek­ing tax deferred solu­tions uti­liz­ing §1031 exchanges or Oppor­tu­ni­ty Zones.

DSTs are not for all investors.  The acqui­si­tion of a DST is for accred­it­ed investors only.  Con­tact your invest­ment advis­er for addi­tion­al details on how a DST may be a solu­tion to your §1031 Exchange and suit­ed for your invest­ment future. For more infor­ma­tion on how to prop­er­ly set up an IRC §1031 Tax Deferred Exchange or if you are an accred­it­ed investor and would like addi­tion­al infor­ma­tion on a DST con­tact Al DiNi­co­la at 239–691-8098 or email adinicola@namcoa.com.

This is not an offer to pur­chase or solic­i­ta­tion to pur­chase any secu­ri­ty, as such be made only through an offer­ing mem­o­ran­dum or prospec­tus.  Invest­ing in secu­ri­ties, real estate, or any invest­ment, whether pub­lic or pri­vate, involves risk, includ­ing but not lim­it­ed to the poten­tial of los­ing some or all of your invest­ment dol­lars when you invest in secu­ri­ties. You should review any planned finan­cial trans­ac­tions that may have tax or legal impli­ca­tions with your per­son­al tax or legal advi­sor.   NAMCOA, LLC is a Reg­is­tered Invest­ment Advi­sor, reg­u­lat­ed by SEC (Secu­ri­ties and Exchange Com­mis­sion). Our cor­po­rate office is locat­ed at 999 Van­der­bilt Beach Road, Suite 200, Naples Flori­da 34108. Secu­ri­ties Offered through MSC-BD, LLC, Mem­ber of FINRA/SIPC. 5 Cen­ter­pointe Dri­ve, Ste. 400 Lake Oswego, OR, 97035. MSC-BD, LLC and NAMCOA are inde­pen­dent­ly owned and are not affil­i­at­ed.

Thank you.