How to Build Wealth Now, Pay Taxes Later with a 1031 Exchange

How to Build Wealth Now, Pay Taxes Later with a 1031 Exchange

4 min read
Dave Foster

Dave Foster is a real estate investor and qualified intermediary, who believes that real estate is an investment in the future.

Dave’s 20 years of experience working in all phases of real estate investing—from large scale development to single family homes and vacation rentals—have given him a keen eye for opportunity and a clear vision for reducing the impact of taxes.

A degreed accountant with a master’s in management, Dave is regional director for Exchange Resource Group and has recently launched his own educational website at Dave has built his reputation on being a driven, results-oriented 1031 exchange qualified intermediary, who works relentlessly to maximize value for the real estate investors he works with.

Dave is inspired by a genuine desire to help those around him succeed and continuously strives to create win-win situations. He has taught numerous certified continuing education courses on investment tax strategies. His particular focus on basic and advanced 1031 exchange topics has made him a popular guest speaker for local Realtor associations, investment clubs, and podcasts. He teaches agents, investors, and advisors alike the ins and outs of 1031 exchanges and other tax and investment options.

Dave started his investing career with a fix and flip duplex, then pivoted to single family housing with a buy and hold strategy. After building a rental portfolio in Denver, a corporate move to the Northeast caused him to transition his holdings into a larger renovation/rental project in his new home city and a Florida vacation rental.

When it became clear that his vacation rental clients were enjoying a lot more sunshine than he was, his family made the move south, and he again relocated his investment dollars. His portfolio has since included single and multifamily long-term rentals, as well as hurricane damaged foreclosures, more vacation rentals, and a commercial building. His current investing focus is on land development and student housing.

The best investment decision Dave ever made has been in spending more time with his family. After just six years as an investor, he was able to use a combination of 1031 exchanges and section 121 primary residence exemptions to generate enough tax-free proceeds for the cash purchase of a sailboat. He lived aboard and enjoyed the adventures of coastal sailing with his family for 10 years.

Now he helps other investors pursue their dreams while he works on a land development project and his four sons finish their academic careers.

Dave has appeared on podcasts such as the Best Real Estate Investing Advice Ever, Landlording for Life, Commit to Wealth, Peer 2 Peer Investing, The Real Estate Syndication Show, Real Estate Nerds, and Can Real Estate Investors Save the World.

Dave is active on the board of the Colorado Online Virtual Academy, the premier college preparatory online charter school in the state of Colorado. A former college basketball player and beach volleyball rat, he was inducted into the Colorado Christian University Athletic Hall of fame in 2007.

Dave earned a B.A. in English, a B.S. in Accounting, and a master’s in Management from Colorado Christian University.


Read More

As a Guest you have free article(s) left

Join BiggerPockets (for free!) and get access to real estate investing tips, market updates, and exclusive email content.

Sign in Already a member?

A 1031 exchange allows you to expand your real estate portfolio with your own tax dollars. As with every other aspect of your real estate investing career, harnessing this powerful tax strategy will require your attention and effort. But if you’ve already purchased and managed an investment property, it’s beyond beneficial to learn how to execute 1031 exchanges.

To get started, you should first determine if a 1031 exchange is appropriate for your property and then calculate your reinvestment requirements.

What is a 1031 Exchange?

Section 1031 of the IRS tax code allows you to sell an investment property and use that money to buy more investment property, as opposed to paying taxes on capital gains. To be sure, the taxes will be due at some point in the future. But by deferring payment, your capital gains will continue to work to your benefit for the time being.

What’s even better, this tax-deferral strategy can work indefinitely—so long as you adhere to certain rules. Here’s how to forecast the gain and tax on your property sale, as well as the 1031 exchange reinvestment requirements to put off that tax hit.

Related: The 1031 Exchange Ultimate Guide for Real Estate Investors

property, for sale, real estate, investment, reinvestment

Does Your Profit Justify a 1031 Exchange?

Before deciding to move forward, your first step should be to determine if there is sufficient gain and tax liability on your transaction to justify a 1031 exchange.

To calculate your gain, subtract closing costs and the adjusted basis from the sale price of your property:

Sale Price – Closing Costs/Commissions/Exchange Fee/Etc. – Adjusted Basis = Gain

Let’s assume a $225,000 selling price, $8,000 in allowable costs and fees, and a $75,000 basis in the property. The gain will amount to:

$225,000 – $8,000 – $75,000 = $142,000

If your tax rate is 15 percent, the federal tax on your gain will be:

$142,000 * .15 = $21,300

So, you’ll have two options: fork over $21,300 to Uncle Sam or complete a 1031 exchange and reinvest it all.

Obviously, your numbers will differ, and it’s up to you to decide which route is best for your specific situation. But many of the best investors are choosing to defer the tax and grow their own holdings with those tax dollars.

Note that, as of this writing, all states with income taxes—except for Pennsylvania—also allow you to defer state tax on gains. (Don’t stress, Pennsylvania investors! You can still defer federal tax and depreciation recapture.)

Related: The Ultimate Guide to Real Estate Investment Tax Benefits

Sell Then Reinvest

Once you decide to move forward, the steps to defer all tax using a basic 1031 exchange are pretty straightforward.

  1. Sell your investment property using a qualified intermediary (QI) to document the process and ensure the transfer of proceeds.
  2. Then, following the time period and title requirements, reinvest the net sale price, including net cash received, into the purchase of another investment property held for productive use of equal or greater value.

1031 Exchange Reinvestment Requirements

Let’s dive deeper into the nitty-gritty of the two reinvestment requirements. In order to defer all tax, the following conditions must be met:

  1. The replacement property that you exchange into must be of equal or greater value than the net sale price of the property that you sold. This is called the “Equal or Up” rule.
  2. You must use all of the net cash received in the purchase of your replacement investment property.

How to Calculate Net Sale Price and Net Cash

When you execute a 1031 exchange, your tax deferral is dependent on the reinvestment of both the net sale price and the net cash received. You can forecast both using the formulas outlined below.

The resulting numbers can be used as an estimate of the amount that you’ll need to reinvest.

investment property, reinvestment, 1031 exchange, calculator


As the sales price of investment real estate does not represent what you actually receive, the IRS allows you to deduct certain associated costs from the sales price. This ends up being advantageous, but it involves some calculating. To determine the net sale price, which is your minimum reinvestment target, plug in the appropriate values in the following equation:

Sales Price – Closing Costs/Commissions/Exchange Fee/Etc. = Net Sale Price

For example, let’s say you’re selling your property for $225,000. Your realtor can provide you with an estimate of closing costs when you are listing the property or the title company will provide them on the final closing documents after the sale.

Let’s assume $8,000 in closing costs, commissions, and the exchange fee for our example:

$225,000 – $8,000 = $217,000 Net Sale Price

So, $217,000 will be your reinvestment target. In other words, in order to defer all tax using our example, you must purchase a replacement property for $217,000 or more.


You must also use all of the cash proceeds in the purchase of the replacement property. This amount is detailed on your settlement statement after closing. It can also be calculated by subtracting any mortgages and/or liabilities from the net sale price.

Net Sale Price – Mortgage/Liabilities = Net Cash (aka Net Proceeds)

Many investors argue that their original cash investment in a property should not be included in the net cash after the sale. It’s money that you put into the property. Why can’t you take it out at this point?

Unfortunately, the IRS doesn’t see it that way—and they create the rules. If you choose to take out even a single dollar of the net cash after your sale, you will pay taxes on any funds not reinvested. That’s even if the property you purchase is of equal or greater value.


In sum, to qualify for a full deferment, you must reinvest all of your net cash into a property that is of equal or greater value than your initial property.

Cover all your bases by consulting with a tax advisor about your personal financial circumstances. Separately, consult with a QI regarding your exchange to ensure you are on the right path. QIs work specifically with 1031 exchanges and are experienced with their nuanced applications.


The 1031 Investor. “Can You Take Money Out of A 1031 Exchange?” Accessed 13 January 2018.

The 1031 Investor. “Equal or Up.” Accessed 13 January 2018.

BiggerPockets. “The 1031 Exchange Ultimate Guide for Real Estate Investors.” Accessed 13 January 2018

Realty Exchange Corporation. “Exchange Reinvestment Requirements.” Accessed 13 January 2018.

blog ads 01

Thinking of applying this tax strategy? Or have you successfully completed a 1031 exchange?

Share your experience below!