How to Use a 1031 Exchange When You Inherit Investment Property
When you inherit investment real estate, it can be both a valuable opportunity and a complex financial decision. Many heirs—especially younger generations—are unsure how to manage their new property or what to do if they want to sell. The good news is that a 1031 Exchange can be a powerful tool for preserving wealth, deferring taxes, and reinvesting for long-term growth.
In this guide, we’ll explore how inheritance and 1031 Exchanges intersect, and what heirs should know before making any major moves.
The Basics: What Happens Tax-Wise When You Inherit Property
When you inherit real estate, the IRS provides a step-up in cost basis, meaning the property’s value is adjusted to its fair market value at the time of inheritance. This step-up effectively wipes out past capital gains, reducing or eliminating tax liability if you sell immediately after inheriting.
However, if you decide to hold the property as an investment, you may later face capital gains taxes on future appreciation when you sell. That’s where a 1031 Exchange can come into play.
How a 1031 Exchange Helps Heirs Preserve Wealth
A 1031 Exchange allows you to sell an investment or business-use property and reinvest the proceeds into another “like-kind” property—deferring capital gains taxes in the process.
For heirs, this strategy can help:
Defer Taxes on Future Appreciation – If your inherited property increases in value, selling it outright could trigger capital gains tax. Using a 1031 Exchange defers those taxes as long as you reinvest according to IRS rules.
Reposition Assets for Better Returns – You can exchange inherited farmland for a commercial rental, or a single-family rental for multiple smaller properties to diversify income streams.
Preserve Family Wealth – Instead of losing a portion of the sale to taxes, more of the equity continues working for you in a new investment.
Example Scenario
Imagine you inherit an apartment building valued at $1 million, with a stepped-up basis equal to that amount. Over time, the property appreciates to $1.3 million.
If you sell it outright, you’d pay capital gains tax on the $300,000 gain.
But if you complete a 1031 Exchange, you can reinvest all proceeds into another investment property — deferring the tax and continuing to grow your real estate portfolio.
Important Considerations
Before proceeding, keep these IRS rules in mind:
The property must be held for investment or business purposes, not personal use.
You’ll need to identify your replacement property within 45 days and close within 180 days.
Always work with a Qualified Intermediary (QI) to handle the exchange process properly.
And if multiple heirs are involved, ownership structure and timing can add complexity — so professional guidance is essential.
Key Insight: Building Generational Wealth Strategically
Younger generations inheriting real estate have an opportunity to grow wealth tax-efficiently by understanding how to apply 1031 Exchange strategies early on. Instead of viewing an inherited property as a quick sale, think of it as the foundation of a long-term investment portfolio.
Disclaimer
This article is for informational purposes only and should not be construed as tax or legal advice. Investors should consult with a tax professional, attorney, or Qualified Intermediary before engaging in a 1031 Exchange or making decisions about inherited property.
