Five Tax Benefits of a 1031 Exchange

Real estate investors know how much taxes can eat into their profits, especially when it comes to selling appreciated commercial property. A 1031 exchange lets you defer those taxes, preserve more of your gains and keep your capital working harder for you.

A 1031 exchange, named after Section 1031 of the Internal Revenue Code, is a tax-deferral strategy that allows investors to sell a property held for business or investment purposes and reinvest the proceeds into a “like-kind” property without immediate tax liability. This allows investors to defer capital gains taxes, potentially increasing their purchasing power and preserving more equity for the future.

Let’s break down the key tax benefits of a 1031 exchange and why this strategy is one of the most powerful tools for building long-term real estate wealth.

Benefit #1 – Defer Federal Capital Gains Tax

When you sell investment real estate for more than you originally paid, the IRS typically taxes your gain between 15% and 20%, depending on your income bracket. But when you complete a 1031 exchange and reinvest in a like-kind property, you can defer capital gains tax until you eventually sell your replacement property outside of a 1031 structure.

Benefit #2 – Defer State Income Tax

Selling appreciated real estate often means owing capital gains tax at both the federal and state levels. In many states, that added tax can be substantial — sometimes over 10%. A properly executed 1031 exchange allows you to defer not only your federal tax but your state income tax as well, provided you meet all IRS requirements. That deferral can make a noticeable difference in your net proceeds and give you more capital to put toward your next investment.

Benefit #3 – Avoid Immediate Depreciation Recapture

Over time, investors typically depreciate their property to reduce taxable income. But when a property is sold, the IRS requires you to “recapture” that depreciation, essentially paying back a portion of those past deductions at a flat 25% rate.

A 1031 exchange allows you to defer depreciation recapture as well, assuming the replacement property is of equal or greater value. This benefit can be especially impactful for long-held properties that have been significantly depreciated over time.

Benefit #4 – Reduce Exposure to Net Investment Income Tax (NIIT)

High earners may also face the 3.8% Net Investment Income Tax (NIIT) on capital gains from real estate sales. This tax applies to individuals with modified adjusted gross incomes above $200,000, or $250,000 for married couples filing jointly. Completing a 1031 exchange may allow you to defer the gain that would otherwise trigger this tax and can reduce your overall tax burden.

Benefit #5 – Reinvest More, Grow Faster

The true power of a 1031 exchange lies in compounding. When you’re not forced to pay capital gains taxes upfront, you can reinvest your full proceeds into higher-value properties or better-performing assets. Over time, that reinvestment power can accelerate portfolio growth and build more equity.

Whether you're consolidating, diversifying or upgrading, using a 1031 exchange keeps your money working harder while pushing your tax obligations down the road.

Maximize Your Tax Benefits with Guidance from Our Expert Team

A 1031 exchange can unlock substantial tax benefits, but only when executed correctly. From strict timelines to documentation requirements, the IRS leaves little room for error. Working with a qualified intermediary who understands the rules and can help you avoid common missteps and protect your gains.

National 1031 is committed to providing the most compliant and secure 1031 exchange services in the United States. Our team has over 20 years of experience handling a wide range of exchange transactions, from simple forward exchanges to complex construction exchanges.

Ready to explore the tax-saving potential of a 1031 exchange? Download our free 1031 Exchange Guide or schedule a call with a National 1031 expert today and see how this strategy can fit your investment goals. 

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