Yes! “Defer, Defer, Die!” sounds terrible phrased like that but this little known benefit of 1031 exchanges is probably its most powerful one. Sure everyone knows a 1031 exchange lets you defer the gain when exchanging one business use or investment property for another but few understand how that works long-term. The gain is deferred as long as you own the replacement property even if you eventually convert the property to personal use.
If you decide to sell that 1031 replacement property and it still qualifies as a business use or investment property, you can exchange into yet another property and continue to defer the gain from both your first and now your second 1031 exchange. There is no limit to the number of times you can exchange assuming you meet the requirements and follow the rules. If you decide to sell and not exchange again, the tax on your gain will be due. If you exchange and trade down in property value or equity, tax will be due only on the amount of your trade down.
So what if you never “just” sell and continue to defer the gain? We know that when exchanging our old basis carries forward to the new property and is increased by the amount of any increase in property value acquired. This is your tax adjusted basis. For individual taxpayers, when you pass away, your assets are passed to your heirs with a stepped up basis. That means they inherit the property with a step up in basis to the fair market value at the time of your death not at your tax adjusted basis. That also means all of the gain deferred is forgiven! Your heirs can immediately sell the property and pay no capital gain taxes.
Of course, it is essential to do some estate planning to minimize the estate taxes for your heirs. Currently, the first $5,000,000 of an estate is exempt from estate taxes and anything after that is taxed at 35% - the lowest it has ever been (except when there was none for one year a few years ago). These current rates are scheduled to sunset at the end of the year and no one has any idea where they will go next so it is important to reassess your estate plan each time the rates change.
Essentially, a 1031 exchange is like a tax-free loan from the government. You can increase the principal (with additional exchanges) and if planned, properly, never repay it. Don’t overlook this powerful strategy to build your real estate portfolio with pre-tax dollars and preserve your wealth.
