There is a piece of received wisdom about appreciated real estate so common it barely gets questioned. If a rental has gone up in value, you don't sell it and hand the IRS a check. You 1031 it and defer, and the gain rolls forward, untaxed, into the next property. Somewhere along the way the exchange stopped being a decision and became a reflex, applied to any property with a gain, as if "you have appreciation" and "you should exchange" were the same sentence.
They are not. Whether to 1031 is a property-by-property call, and it turns on two things: how large the embedded tax actually is against the equity, and what the client needs that capital to do. Produce income? Free up liquidity? Come out of a position that has grown too concentrated? You cannot eyeball either one. And in the same household, run two properties instead of one, and the answer can bend in opposite directions.
We saw exactly that recently. A couple, two rentals, one advisor at the table.
The first was a coastal rental they had owned for decades and long since paid off, free of any mortgage, its value up more than $950,000 over the years. On paper it looked like a keeper. But it was barely working. The rent, measured against the equity sitting in it, threw off close to one percent a year. That is dead money. And selling it outright would be brutal, because a low basis and decades of appreciation add up to a tax of about $252,000, nearly a fifth of the equity in the property.
That is where the exchange earns its place. A 1031 into a diversified replacement defers the entire $252,000 and, at the same time, turns equity that was earning barely one percent into roughly $50,000 a year of income. A real tax worth deferring, and a goal the exchange actually serves: dead capital put back to work as income. For this property, the reflex is right.
The second property looked, at a glance, like the same story. Appreciated, valuable, an obvious candidate to exchange, so the reflex fired again. 1031 it, don't pay the tax. But this one was different in every way that mattered. They had bought it only a few years ago. It was bleeding about $48,000 a year, roughly $4,000 a month out of their own pockets, a part-time vacation rental they were quietly subsidizing. And the tax to sell it was about $72,000, under eight percent of the equity. A factor, not a barrier.
For that property, the exchange is the wrong move. A 1031 would defer a modest tax by re-chaining them into another illiquid asset on a five-to-ten-year clock, exactly when the entire point was to get out, free the cash, and stop the bleed. Here the reflex is wrong. Just sell, pay the modest tax, and redeploy.
Sit with that. Same couple, same advisor, the same instinct applied to both, and the right answer landed on opposite sides. On the first property, the embedded tax was nearly a fifth of the equity and the asset was dead money, so deferring it and converting to income was the win. On the second, the tax was a sliver and the asset was a cash drain, so paying it and leaving was the win. Nothing about the two properties told you which was which from the outside. You had to run each one, and read the tax against what these owners actually needed the money to do.
This is what the reflex skips. A lot of the pressure toward the exchange comes from people who do well when it happens. The intermediary who holds the proceeds and the sponsor who sells the replacement property are both paid when the trade closes. Add the client's own instinct to never pay a tax they could defer, and the exchange can feel settled before anyone runs a number. The advisor is the one person in the room positioned to ask a different question. Not "how do we avoid the tax," but "what does this capital need to do for the client, and does an exchange actually get it there?" Sometimes the tax is the biggest number on the page and the exchange is the cleanest route to the goal. Sometimes it is a rounding error against the equity, and chasing it pulls the client away from what they actually needed.
You cannot answer that with a rule of thumb, and you cannot answer it for a whole household in one stroke. You answer it one property at a time, by running the actual sale, the actual tax, and the actual income the capital could produce somewhere else. The advisor who does that walks into the meeting already knowing which way each fork bends. The one who trusts the reflex exchanges the property that should have been sold, and sells the one that should have been exchanged, and never sees the difference.
Market Implications Right Now
The exchange branch also has a hard clock on it, and right now that clock is running through the worst market in a generation to beat it.
To defer the tax, a client has to identify replacement property within forty-five days of the sale and close within a hundred and eighty. That is manageable when there is inventory to buy. It is brutal when there is not. The National Association of Realtors put 2025 existing-home sales at roughly 4.06 million, the fewest since 1995 and a fourth straight year of decline, against a historical norm closer to 5.2 million. Sellers are pulling listings rather than cutting prices. Inventory that fits a specific exchange, in a specific market, at a price that works, is scarce.
Here is why that sharpens the fork. A failed identification does not pause the tax. It means the client already sold, the clock ran out, and now they owe the full bill anyway, with no property to show for it and their capital sitting in an intermediary's account. The reflexive "just 1031 it" was always a bet that the right replacement would appear in time. In a frozen market, that bet costs more and pays off less often.
So the friction on the exchange rose at the exact moment the transaction market seized up. That does not argue against exchanges. It raises the bar for taking one. When the embedded tax is nearly a fifth of the equity, deferring it can be worth a forty-five-day sprint and a lockup. When it is a sliver, it is not, and the reflex is asking the client to take on real risk to avoid a small bill. The only way to know which case you are in is to run the number, on that property, before the decision is made.
Leveridge models exactly this for every investment property in a client's portfolio: hold, sell, or exchange.
