When to Consider a 1031 Exchange
A 1031 exchange allows you to exchange a piece of real estate for another piece of real estate without paying capital gains taxes. Consider a 1031 exchange ONLY when continuing to hold property in your portfolio makes the most sense BEFORE considering taxes.
The people who actively switch among rental properties will use 1031 exchanges to keep a low-cost basis and avoid paying capital gains taxes. When they die, their property is passed to their heirs and it gets a step-up in basis which means the heirs can sell without paying any capital gains taxes.
Unfortunately, we can be so focused on avoiding tax that we end up holding a dead asset for years or even decades. Sometimes it’s better just to pay the tax and reinvest in a productive portfolio, especially if your time horizon is long.
For this reason, we want to ONLY consider a 1031 exchange when we know we would purchase the new rental property even without this tax benefit. This is a classic case of let’s not let the tax savings cause us to limit our own growth in income and wealth.