Considering Selling Investment Real Estate?

Sell­ing appre­ci­at­ed invest­ment real estate can cre­ate an impor­tant tax and invest­ment deci­sion.

Before your prop­er­ty clos­es, under­stand:

  • Your poten­tial tax­able gain
  • Whether a Sec­tion 1031 exchange should be con­sid­ered
  • How much equi­ty may be avail­able for rein­vest­ment
  • Your replace­ment-prop­er­ty options
  • The 45-day and 180-day exchange dead­lines

The best time to plan is before the sale clos­es.

Start With the Num­bers

Before decid­ing whether to sell, exchange, or rein­vest, esti­mate:

Sale Price
Debt Pay­off
Adjust­ed Tax Basis
Depre­ci­a­tion
Esti­mat­ed Cap­i­tal Gain
Esti­mat­ed Tax­es
After-Tax Equi­ty

Cap­i­tal Gains & 1031 Tax Esti­ma­tor

Com­pare the esti­mat­ed cap­i­tal avail­able if you:

Sell and pay the tax

ver­sus

Com­plete a qual­i­fy­ing Sec­tion 1031 exchange

Sell or Com­plete a 1031 Exchange?

Sell & Pay TaxQual­i­fy­ing 1031 Exchange
Pay applic­a­ble tax­es nowPoten­tial­ly defer eli­gi­ble gain
Greater invest­ment flex­i­bil­i­tyCap­i­tal remains in qual­i­fy­ing real estate
No 45/180-day dead­linesStrict exchange dead­lines apply
Imme­di­ate access to after-tax pro­ceedsExchange pro­ceeds must be prop­er­ly han­dled
No replace­ment-prop­er­ty require­mentReplace­ment prop­er­ty must qual­i­fy

A Sec­tion 1031 exchange can pre­serve cap­i­tal through tax defer­ral.

Tax defer­ral, how­ev­er, does not guar­an­tee a suc­cess­ful invest­ment.

If You Are Con­sid­er­ing a 1031 Exchange

In a typ­i­cal delayed exchange, plan­ning should begin before clos­ing.

Before the Sale Clos­es

☐ Esti­mate your tax­able gain
☐ Speak with your CPA or tax advis­er
☐ Decide whether a 1031 exchange is appro­pri­ate
☐ Select a Qual­i­fied Inter­me­di­ary
☐ Estab­lish the exchange before clos­ing
☐ Begin eval­u­at­ing replace­ment prop­er­ties

Receiv­ing or con­trol­ling the sale pro­ceeds before prop­er­ly estab­lish­ing the exchange can jeop­ar­dize Sec­tion 1031 treat­ment.

45 Days

Replace­ment prop­er­ty gen­er­al­ly must be prop­er­ly iden­ti­fied with­in 45 days after the relin­quished prop­er­ty is trans­ferred.

180 Days

Replace­ment prop­er­ty gen­er­al­ly must be acquired by the ear­li­er of:

180 days after the trans­fer, or

the applic­a­ble fed­er­al income-tax return due date, includ­ing exten­sions.

Because these dead­lines are strict, replace­ment-prop­er­ty plan­ning should ide­al­ly begin before clos­ing.

Replace­ment-Prop­er­ty Choic­es

Direct Real Estate

Pur­chase and direct­ly own anoth­er qual­i­fy­ing invest­ment prop­er­ty.

Best suit­ed for investors who want:
Con­trol, direct man­age­ment, financ­ing flex­i­bil­i­ty, and author­i­ty over the even­tu­al sale.

Delaware Statu­to­ry Trusts

Cer­tain prop­er­ly struc­tured DST inter­ests may poten­tial­ly qual­i­fy as replace­ment real prop­er­ty.

Poten­tial con­sid­er­a­tions include:
Pas­sive own­er­ship, pro­fes­sion­al man­age­ment, frac­tion­al invest­ment siz­ing, and access to larg­er com­mer­cial prop­er­ties.

Direct Prop­er­ty + DSTs

Some investors may com­bine direct­ly owned replace­ment real estate with one or more DST inter­ests.

This can pro­vide addi­tion­al flex­i­bil­i­ty when allo­cat­ing exchange pro­ceeds.

Mul­ti­ple Replace­ment Prop­er­ties

Exchange pro­ceeds may poten­tial­ly be divid­ed among sev­er­al qual­i­fy­ing prop­er­ties.

This can help diver­si­fy expo­sure across:

  • Prop­er­ties
  • Mar­kets
  • Asset class­es
  • Spon­sors

Diver­si­fi­ca­tion does not elim­i­nate risk.

Which Replace­ment-Prop­er­ty Approach Fits Your Goals?

Some investors want con­trol. Oth­ers want pas­sive own­er­ship. Some want one prop­er­ty, while oth­ers want sev­er­al. These four approach­es can help frame the replace­ment-prop­er­ty deci­sion before the 45-day iden­ti­fi­ca­tion peri­od begins to cre­ate pres­sure.

Direct Real EstateDelaware Statu­to­ry TrustsCom­bi­na­tion Strat­e­gyMul­ti­ple Replace­ment Prop­er­ties
Own anoth­er replace­ment prop­er­ty direct­ly.Poten­tial pas­sive replace­ment-prop­er­ty option for cer­tain 1031 investors.Use direct real estate plus one or more DSTs.Allo­cate exchange pro­ceeds across sev­er­al qual­i­fy­ing prop­er­ties
Best for: Con­trol, flex­i­bil­i­ty, active own­er­shipBest for: Pas­sive own­er­ship, pro­fes­sion­al man­age­ment, diver­si­fi­ca­tionBest for: Blend­ing active and pas­sive own­er­shipBest for: Diver­si­fi­ca­tion across assets, mar­kets, or spon­sors
Trade-off: More respon­si­bil­i­tyTrade-off: Less con­trol, lim­it­ed liq­uid­i­tyTrade-off: More mov­ing partsTrade-off: Diver­si­fi­ca­tion does not elim­i­nate risk
    

How Much Do You Need to Rein­vest?

This ques­tion is often over­sim­pli­fied as:

“You must replace all of your debt.”

That is not always the best way to ana­lyze the trans­ac­tion.

For investors seek­ing full defer­ral, the cal­cu­la­tion may con­sid­er:

  • Replace­ment-prop­er­ty val­ue
  • Equi­ty rein­vest­ed
  • Debt relieved
  • Replace­ment financ­ing
  • Addi­tion­al cash con­tributed
  • Cash or oth­er prop­er­ty received

Your CPA or tax attor­ney should deter­mine the require­ments for your spe­cif­ic trans­ac­tion.

Do Not Let the Dead­line Make the Invest­ment Deci­sion

The 45-day iden­ti­fi­ca­tion peri­od can cre­ate pres­sure.

As the dead­line approach­es, the ques­tion can become:

“What can I buy before my 45 days expire?”

A bet­ter ques­tion is:

Would I buy this invest­ment if there were no 1031 dead­line?

If the answer is no, the tax dead­line should not make the invest­ment more attrac­tive.

Tax Defer­ral Pre­serves Cap­i­tal. It Does Not Cre­ate Invest­ment Val­ue.

Before Choos­ing Replace­ment Prop­er­ty

Ask your­self:

IncomeDo I need cur­rent income or month­ly cash flow?
Liq­uid­i­tyHow long can I com­mit my cap­i­tal?
Man­age­mentDo I want to remain an active land­lord or move toward pas­sive own­er­ship?
Con­trolDo I want to make prop­er­ty-lev­el deci­sions myself?
RiskHow much lever­age, mar­ket risk, and illiq­uid­i­ty am I com­fort­able accept­ing?
Diver­si­fi­ca­tionDo I want one replace­ment prop­er­ty or sev­er­al?
Long-Term Strat­e­gyHow does this deci­sion fit my tax, invest­ment, retire­ment, and estate-plan­ning objec­tives?

A Sim­ple Pre-Sale Time­line

BEFORE CLOSINGEsti­mate tax­es → Decide whether to exchange → Select QI → Begin replace­ment-prop­er­ty research
CLOSING DAYRelin­quished prop­er­ty is trans­ferred
DAYS 1–45Iden­ti­fy qual­i­fy­ing replace­ment prop­er­ty
BY THE APPLICABLE EXCHANGE DEADLINEAcquire qual­i­fy­ing replace­ment prop­er­ty
AFTER THE EXCHANGEEval­u­ate the invest­ment based on per­for­mance, income, risk, financ­ing, and long-term objec­tives

Could a DST Be Appro­pri­ate?

A DST may war­rant con­sid­er­a­tion if you:

☐ Are sell­ing appre­ci­at­ed invest­ment real estate
☐ Want to explore Sec­tion 1031 tax defer­ral
☐ Want less prop­er­ty-man­age­ment respon­si­bil­i­ty
☐ Pre­fer pas­sive real estate own­er­ship
☐ Want pro­fes­sion­al man­age­ment
☐ Have a longer invest­ment hori­zon
☐ Do not require imme­di­ate liq­uid­i­ty

A DST may be less appro­pri­ate if you need short-term liq­uid­i­ty, want direct prop­er­ty con­trol, or are uncom­fort­able with pri­vate real estate invest­ment risk.

Five Things to Do Before You Sell

1. Know Your Tax Expo­sure  Esti­mate your poten­tial gain and tax­es.  
2. Decide Ear­ly  Deter­mine whether you want to pur­sue a Sec­tion 1031 exchange before clos­ing.  
3. Engage a Qual­i­fied Inter­me­di­ary  Do not wait until after the sale.  
4. Eval­u­ate the Invest­mentDo not allow a tax dead­line to replace due dili­gence.
5. Think Beyond Tax Defer­ral  Focus on how your cap­i­tal should be invest­ed after the sale.  

Con­tin­ue Your Edu­ca­tion

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