Is a 1031 exchange worth it?

Question

If I am potentially going to make 80,000 to 100,000 profit in a fix and flip that will possibly sell for around $500,000, is it worth putting the money into a 1031 exchange?  I don't want to buy another property of that value. I would like to buy 2-3 long term rentals next.

Dave Foster · Answer

@Angela Revere, a 1031 can be worth it for lots of investors, but is it worth it for you? Well, as @Chris Seveney said, that depends. If you have a $100k gain, you might owe close to $25k of tax, depending on your state, and that's excluding depreciation recapture, so it might be closer to $30k by the time the dust settles.

There is an added element that could cause issues with you - You're calling this a fix-and-flip.  Technically, fix-and-flips don't qualify for 1031.  But the actions you took and your intent can play a big role in whether or not it qualifies.  I'll reach out via PM in case you have questions.

Your average cost for a qualified intermediary to perform a 1031 exchange for you will be around $950, which looks pretty good next to a $25k tax bill. The trick is to find a QI that is established and experienced enough to give you good guidance and service.  And big enough to offer economies of scale.  But small enough to give you prompt personal attention. Go be Goldilocks - find the "just right one for you".

Ashish Acharya · Answer

Hey Angela, this is actually one of the more common misconceptions about 1031 exchanges. Unfortunately, like others mentioned above and touched on, a 1031 exchange isn't going to work for this situation. Fix and flips are generally considered inventory in the eyes of the IRS, not investment property held for productive use. The 1031 exchange rules under Section 1031 specifically require the property being sold to have been held for investment or business use, and flips typically don't meet that bar since the intent from day one was to buy, renovate, and sell quickly for profit.

Profit from flipping is usually taxed as ordinary income and can also be subject to self-employment tax if you're doing this as a regular business activity, which is a different tax treatment entirely from the capital gains a 1031 is designed to defer.

The good news is you could use the proceeds from this flip to fund 2-3 long-term rentals, you'll just be paying tax on the flip profit first before reinvesting. Depending on how many flips you do per year and how this activity is structured, there may be ways to manage the tax hit, but a 1031 exchange specifically isn't going to be one of the available tools here. Or you could keep these, turn them into rentals and see how it interplays with your overall income sources and make the most of taxes that way and then eventually do the 1031.

I'd definitely connect with a CPA who specializes in real estate, look at your specific activity level and entity structure, and help you navigate your next move and make sure everything is set up efficiently tax-wise.

Best of luck and happy to connect!

Rick Albert · Answer

Fix and flip is taxed as ordinary income, you can't do a 1031 exchange. The IRS views it as an active activity.

If you fixed it up and rented it for a period of time, then you can consider it. Talk to a CPA to understand not just the tax implication, but also depreciation recapture.

Also keep in mind you can buy up to 3 properties (some exceptions can apply). So if the concern is spending $500K on one property, you have other options.

You said you would like to buy long terms rentals, so if that's the case why wouldn't you consider a 1031 exchange if you are already selling a past rental?

Fulton Abraham Sanchez · Answer

@Angela Revere, hi. The first question is not whether the exchange is worth it, it is whether the property qualifies. If it was acquired and renovated primarily for resale, it may be considered property held for sale, which is excluded from Section 1031.

If it qualifies as investment property, you can exchange one property into two or three rentals; you do not need to purchase one $500,000 replacement. However, cash retained or value not replaced may make part of the gain taxable. Review the structure with your CPA before closing because the exchange must be arranged before you receive the sale proceeds.

Vijay Friedman · Answer

@Angela RevereCongrats on the flip! Before making a decision, I'd definitely confirm with a qualified intermediary or tax advisor whether the property qualifies for a 1031 exchange, since treatment can differ depending on how the property was held. If your goal is to build a rental portfolio, it's also worth comparing the tax savings against the flexibility of using the proceeds for multiple acquisitions.

Basit Siddiqi · Answer

a 1031 exchange for a flip might be a no-no.You had to have the intent during the purchase to treat it as an 'investment'.Best of luck

Aaron Zimmerman · Answer

If it's a fix and flip, you likely can't 1031 exchange this property.

Jason Malabute · Answer

The most important thing to flag here is that a true fix-and-flip usually won't qualify for a 1031 exchange in the first place. The IRS treats flips as property held for resale, so that profit gets taxed as ordinary income rather than as a capital gain you can defer, and it really comes down to your intent and how the property was actually used rather than any set holding period. If you had held it as a rental for a while before selling, you'd have a much stronger case to roll it into your next rentals, and you're allowed to line up as many as three replacement properties. On a $100k gain you could be looking at roughly $25k to $30k in tax once you add in your state and any depreciation recapture, while a qualified intermediary usually runs around $950, so an exchange is well worth it when you actually qualify for one. The exact answer really depends on your specific facts, so it's worth running this by your own CPA before you sell.

Angela Revere · Answer

I'm selling a fix and flip and want to buy a couple of long term rentals. Is This not eligible?  Thank you all for the info.

Josh C. · Answer

I was under the assumption you could not use a 1031 exchange for fix and flip. Needed to be a rental or at the bare minimum your intention was a rental.

Is a 1031 exchange worth it?

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