Selling three rental houses after nearly three decades of ownership feels like the definition of a financial win, but the tax bill that arrives alongside it can take a significant portion of that win before the landlord has a chance to spend or reinvest any of it.
For a 66-year-old with $1.4 million in combined property value, a $400,000 original cost basis, and $300,000 in accumulated depreciation, a straightforward cash sale triggers roughly $250,000 in federal taxes. A properly structured 1031 exchange defers all of it.
The exchange does not eliminate the tax, it just postpones it indefinitely, potentially until death, at which point heirs receive a stepped-up basis that eliminates the embedded gain entirely under current law. For a landlord ready to retire but not ready to hand the IRS $250,000, the 1031 path is worth understanding in full before the first property hits the market.
The Tax Math Behind the Decision
A cash sale on all three properties at $1.4 million produces approximately $720,000 in long-term capital gains after accounting for the adjusted cost basis, plus $300,000 in depreciation recapture from the deductions claimed over the ownership period.
Long-term capital gains at this income level are subject to a combined federal rate of 23.8%, including the new investment income tax, resulting in approximately $171,000 in LTCG tax. Depreciation recapture is taxed up to 25% regardless of the taxpayer’s capital gains bracket, adding another $75,000. All totaled, he combined federal bill runs to approximately $246,000 before any state capital gains taxes are layered on top.
A completed 1031 exchange under IRC §1031 defers every dollar of that liability. The three properties are sold, the proceeds flow through a Qualified Intermediary rather than touching the landlord’s bank account, and replacement property of equal or greater value is acquired within the statutory timeline. No gain is recognized, no depreciation recapture is triggered, and the tax basis carries forward into the new property.
The Timeline and the Rules
Post-TCJA, Section 1031 applies exclusively to real property held for investment or business use. Personal property, vehicles, and equipment no longer qualify, however, three rental houses qualify because they are real property held as investment assets, and the replacement property must be real property of like-kind, a broad standard under which virtually any US investment real estate qualifies as like-kind to any other US investment real estate.
The timelines are strict and unforgiving, the replacement property must be identified in writing within 45 days of the first sale closing, and the exchange must be completed, meaning the replacement property must close, within 180 days of that same date.
Missing either deadline by a single day collapses the exchange and makes the full gain immediately taxable. Using an experienced Qualified Intermediary is not optional, as taking constructive receipt of the sale proceeds at any point disqualifies the exchange entirely.
The DST Option for a Retiring Landlord
A Delaware Statutory Trust is a legal structure that allows multiple investors to hold fractional ownership interests in a single large commercial property, with professional management handling all operations.
For a retiring landlord who wants to exit active property management without triggering a taxable event, a DST qualifies as like-kind replacement property for 1031 exchange purposes while completely eliminating tenant calls, maintenance decisions, and lease negotiations.
The tradeoff is liquidity and control, as DST interests are illiquid and the investor has no operational input. However, for a 66-year-old whose primary goal is income without management headaches, that tradeoff is often the point rather than the problem. The replacement property produces passive income, the gain remains deferred, and the step-up basis at death remains available to heirs under current law.
Partial Exchange When Some Cash Is Needed
Landlords who want to access some liquidity without sacrificing the full deferral can structure a partial exchange with boot. Boot is the portion of the proceeds not reinvested in like-kind property, and it is taxable in the year of the exchange to the extent of gain.
Exchanging $1.4 million in properties and acquiring $1.2 million in replacement property, for example, leaves $200,000 in boot that is taxable, while the remaining $1.2 million stays in the exchange and continues to defer the proportional share of the gain.
The strategy allows selective liquidity without abandoning the exchange entirely, and the Qualified Intermediary can structure the transaction accordingly before any property closes.
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