What Tax Season Is Revealing About Today’s 1031 Exchanges

For over 100 years, the 1031 exchange has been the default solution following the sale of investment real estate. Defer the gain, identify a replacement property, and move forward. But as Tax Day approaches, many advisers are taking a more comprehensive planning approach, beginning with a key question: Does a full exchange still align with the investor’s broader financial objectives? 

Today’s economic environment makes executing exchanges more complex. Higher borrowing costs, limited inventory, and short identification timelines are forcing trade-offs for investors. To replace leverage, investors have had to accept lower income, higher risks, and longer investment periods than what could previously be achieved.

If the original disposition was driven by goals such as reducing liability, improving income, simplifying management, or creating liquidity, reinvesting all proceeds and replacing debt at today’s rates may not fully achieve the client’s goals.

What’s Surfacing During Tax Season

Tax season brings these challenges into focus. For many investors, it is not until draft returns are prepared that the magnitude of deferred gain, or future taxable income, becomes clear. Some remain in cash months after a sale, still searching for replacement options. Others are mid-exchange and finding available opportunities misaligned with income needs or risk tolerance.

Exchange rules limit an investor’s ability to reposition across markets within strict timelines, while interest rates, operating costs, and inflation are unlikely to shift during identification periods.

Another realization often emerges. While investors build wealth over time through tax deferral, replacement property income may now carry a meaningful ordinary income burden. In leveraged scenarios, taxable income can significantly exceed cash flow due to debt amortization and a low carryover basis, resulting in limited ongoing depreciation benefits – the dreaded phantom income. 

When a 1031 Exchange Isn’t the Whole Plan 

The 1031 exchange remains a powerful wealth-building tool, but increasingly functions as only one component within a broader planning framework. Tax season creates a natural checkpoint to evaluate after-tax income, leverage exposure, and portfolio durability. While depreciation and cost recovery can shelter income for a period, benefits vary by asset type and structure, individual circumstances, and may not fully offset exchange-generated income. 

The Role of Complementary Tax Strategies 

Recent tax code provisions have expanded planning flexibility. Certain qualifying real estate investments may generate accelerated depreciation benefits, often called bonus depreciation, which can offset current and future taxable income, subject to eligibility and other limitations.

When paired with an exchange, these structures may help address planning gaps.

Potential outcomes may include:

• Creating flexibility around liquidity;
• Managing future taxable income;
• Adjusting replacement leverage; and
• Diversifying into more liquid investment structures.

These approaches are not replacements for the 1031 exchange but may complement it as part of a broader plan.

An Evolving Planning Conversation 

As exchanges grow more complex, investors are seeking guidance beyond transaction execution. Advisers who integrate tax strategies, income planning, and risk management into exchange discussions are better positioned to help clients navigate today’s constraints while pursuing long-term objectives.

The conversation is not about abandoning the 1031 exchange but broadening the planning lens around it.

Using Tax Season as a Reset 

Tax Day can serve as more than a deadline. It can be a strategic reset point. When advisers use this moment to reassess tax efficiency within the broader investment plan, conversations shift from reactive decisions to intentional planning. In a market where the 1031 exchange is no longer one-size-fits-all, this shift often leads to more meaningful outcomes. 

LEARN MORE: For advisors and investors interested in exploring how tax efficiency can complement exchange planning, InCommercial’s upcoming educational webinar will examine real estate investment structures and portfolio considerations relevant to today’s environment. Register for the Webinar >