1031 Exchange

A 1031 exchange is one of the most powerful — and most underutilized — tools available to real estate investors.

Named for Section 1031 of the Internal Revenue Code, it allows a property owner to sell an investment property, reinvest the proceeds into a “like-kind” replacement property, and defer capital gains taxes that would otherwise be due at the time of sale. Done correctly and repeatedly, a 1031 exchange can allow an investor to compound their wealth across decades — deferring taxes indefinitely and, under current law, potentially eliminating them altogether upon the transfer of the asset to heirs.

At Thomson·Danforth, 1031 exchanges are woven into nearly everything we do. Whether we are representing a seller, helping a buyer identify replacement property, or advising a client on how to restructure their portfolio, understanding the exchange process — and knowing how to navigate it — is central to the value we provide.

The Basics

To qualify for 1031 exchange treatment, a few key rules apply:

The property being sold (the “downleg”) and the replacement property (the “upleg”) must both be held for investment or productive use in a trade or business — not personal use or resale. From the close of the downleg sale, the investor has 45 days to formally identify potential replacement properties, and 180 days to close on the acquisition. Both deadlines are strict, and missing either one disqualifies the exchange.

To defer all capital gains, the investor must reinvest all net proceeds and replace or exceed the debt on the property sold. Partial exchanges are possible — but any proceeds not reinvested (“boot”) are taxable in the year of the sale.

Getting More Time: The Extended Escrow Strategy

One of the most practical advantages we bring to the table is our ability to negotiate seller-friendly escrow terms on the downleg. In many cases, we are able to convince buyers to grant the seller an extended or flexible escrow period — allowing the seller more time to identify and get comfortable with replacement property options before the 45-day clock even starts. This simple but often overlooked strategy can make an enormous difference in the quality of the exchange outcome, reducing pressure and expanding the seller’s options when it matters most.

Is Your Equity Working Hard Enough?

Before deciding what to exchange into, we think it’s worth asking a more fundamental question: how hard is your current equity actually working for you?

As a property appreciates and a loan pays down over time, investors accumulate equity — sometimes substantial equity — that is sitting inside a building and generating a return based on the original purchase price, not the current value. When you calculate the actual return on that equity today, relative to what the property is producing, the number is often surprisingly low.

A 1031 exchange is an opportunity to reset that equation — to take equity that has been quietly underperforming and redeploy it into an asset where it can generate a stronger return. The right replacement property depends on the client’s goals, but here are the paths we most commonly explore:

Option 1: Scale Up — More Units or Larger Commercial

For investors whose primary goal is continued growth, exchanging into a larger multifamily or commercial asset is often the most direct path to maximizing return on equity. A client who purchased a six-unit building a decade ago may now hold enough equity to acquire a 20- or 30-unit building — dramatically increasing both income and long-term wealth-building potential. We help clients model out what their equity could produce in a larger asset and identify the right opportunities in the right markets.

Option 2: NNN Retail — Retire from Management

For investors who have spent years managing tenants, maintenance calls, and operating expenses, a triple net (NNN) leased retail property can feel like a revelation. In a NNN structure, the tenant — typically a corporate or franchise retailer — assumes responsibility for property taxes, insurance, utilities, and all maintenance and repairs. The landlord simply collects rent.

These leases are typically long-term — 10 to 25 years — with annual rent increases and corporate guarantees, located in high-traffic retail corridors with strong demographics. And because Bay Area properties tend to trade at relatively compressed cap rates, clients selling locally and acquiring NNN assets elsewhere in the country frequently see a meaningful increase in monthly cash flow in the process — sometimes dramatically so.

We have completed NNN exchange transactions in over half the states in the country and have deep experience identifying the right tenant, location, and lease structure for each client’s situation. (See our Commercial Investments page for more on NNN.)

Option 3: Delaware Statutory Trusts (DSTs) and Other Passive Investments

For investors who want to exit active property ownership entirely — or who need a fast, reliable closing within the constraints of the exchange timeline — Delaware Statutory Trusts (DSTs) offer a compelling alternative.

A DST is a professionally managed, institutional-grade real estate investment that qualifies as like-kind replacement property under IRS rules. Investors purchase a fractional ownership interest in a property that has already been acquired, financed, and is under professional management. There is nothing to operate, no financing to arrange, and no tenants to manage. Monthly distributions flow directly to investors, and the tax benefits of direct real estate ownership — including depreciation — pass through on a pro-rata basis.

DSTs are particularly well-suited to 1031 exchanges for a few reasons: they can close in as few as three business days, making them an excellent solution for investors approaching their 45-day identification deadline or as a backup nomination alongside a primary target. Low minimum investments (typically around $100,000) also allow investors to spread proceeds across multiple properties, adding diversification that a single sole-owned acquisition can’t provide. And like any 1031 exchange, the deferral can be carried forward indefinitely — with heirs potentially receiving a stepped-up basis that eliminates accumulated gains entirely under current tax law.

Option 4: Vacation or Second Home with Rental Income

For investors who want their replacement property to do double duty — generating income and providing personal enjoyment — a vacation rental can qualify as like-kind exchange property under the right conditions. The IRS requires that the property be rented out at fair market value for at least 14 days per year, and that personal use be limited to no more than 14 days or 10% of the days it’s rented, whichever is greater. With proper planning and consistent rental activity, many investors successfully exchange into a beach house, mountain retreat, or other desirable destination property that they can also visit and enjoy.

It’s worth noting that the rules here require careful attention, and we always recommend working closely with a qualified tax advisor to structure this correctly. But for the right client — particularly those thinking about how their investments align with the next chapter of their lives — it’s an option well worth exploring.

A Note on Professional Guidance

1031 exchanges are powerful, but they are also time-sensitive and rule-bound. We work closely with our clients’ tax advisors and qualified intermediaries to ensure every exchange is structured correctly from the start. If you don’t already have a qualified intermediary or exchange-experienced CPA in your corner, we’re happy to make introductions.

Whether you’re just beginning to think about a sale or already in escrow, the earlier we can have the conversation, the more options you’ll have. Reach out to Thomson·Danforth for a confidential consultation.