Optimizing the 2025 Residential Real Estate Market Through 1031 Exchanges
Springtime often sees an increase in real estate buyer activity. But before single-family homeowners and investors spring into action, understanding the economics of the current residential real estate market is paramount.
While affordability remains a major concern, there are signs of gradual improvement. And as noted by First American Financial Corp. deputy chief economist Odeta Kushi, "where housing inventory grows, sales follow." This signals that strategic sellers in markets with increasing inventory may find favorable conditions. In addition, the 2025 housing market predictions suggest a slow but steady progression, emphasizing the importance of informed decision-making.
Additionally, every “selling season” is paired up with tax season — which brings its own nuances and considerations. To maximize financial gains and reduce tax liability, it is important for single family homeowners and investors to understand the interplay between these factors. Investors, in particular, should also understand the rules and requirements of using 1031 exchanges.
MAXIMIZING GAINS BY DEFERRING TAXES
Section 1031 of the Internal Revenue Code empowers investors to preserve equity and save in taxes, at least temporarily, through tax-deferred exchanges. In a 1031 exchange, you can defer the payment of capital gains taxes when you sell investment property and acquire “like kind” replacement property. The definition of “like-kind” is fairly broad and includes all real estate uses. Taxes are owed when you sell the replacement property. However, if you do another 1031 exchange, and continue to do so when you sell, you can defer the capital gains indefinitely.
If a single-family rental investor in California wants to diversify into a different property type, such as a multifamily property or industrial property in New Jersey and New Mexico, for example, a 1031 exchange can facilitate this transition without triggering immediate tax liabilities. While all U.S. property is like-kind with other U.S. property, foreign real estate is not like-kind to real estate in the 50 states, even if it is in an affiliated commonwealth or territory such as Puerto Rico.
If you own a single-family house as your primary residence and want to leverage a 1031 exchange down the road, there are a number of considerations that need to be factored in well in advance.
First, you will have to move out, convert the residence to a rental property, and rent it for a sufficient length of time to show the investment intent required to conduct a 1031 exchange and avoid paying the capital gains taxes. This approach may make sense in high-appreciation markets such as California, where homeowners who have seen significant gains in their primary residences want to leverage 1031 exchanges in conjunction with Section 121 exclusions.
Homeowners who convert a primary residence into a rental property for a couple of years can exclude up to $500,000 (for married couples filing jointly) of the gain tax-free under Section 121, because they resided in the property during two of the preceding five years. Then the remaining proceeds can be rolled into a 1031 exchange to defer the tax on the balance.
For homeowners who prefer not to sell, converting their primary residence into a rental property can also offer a good alternative. Conversion allows for long-term income generation as well as potential appreciation, while still providing some valuable tax benefits.
CHOOSING THE RIGHT REAL ESTATE INVESTMENT STRATEGY
For those who already own a single-family home as an investment property, there are different strategies to consider and explore so that you can mitigate risk and maximize success. One strategy is using a 1031 exchange to defer capital gains taxes and allow proceeds to be reinvested into new investment properties.
Given the market's gradual improvement, sellers can proactively identify potential replacement properties. A reverse exchange allows investors who have the available capital to secure a new property before they sell their existing one. This type of strategy can also help to mitigate risks that are associated with tight inventory and potential delays from identifying suitable replacements within the 45-day window.
REMEMBERING THE 1031 EXCHANGE EXTENSION
For those who initiated a 1031 exchange late in 2024, tax deadlines can have an impact on the exchange period. The exchange period lasts either 180 days or until the taxpayer's income tax filing deadline, whichever comes first. So, if your filing deadline falls before your exchange deadline, you would need to file for an extension to obtain the full 180-day period.
- For taxpayers with a March 15 filing deadline, if you sold your relinquished property on or after September 16, 2024, you would need to file for an extension to have a full 180-day exchange period.
- For taxpayers with an April 15 filing deadline, if you sold your relinquished property on or after October 17, 2024, you would need to file for an extension to have a full 180-day exchange period.
While filing an extension is not required, investors should be aware of this limitation and discuss it with their tax advisor and exchange officer to ensure a smooth transaction.
RECEIVING TAX BENEFITS WHEN ALL ELSE FAILS
Another thing to keep in mind is that a failed exchange that straddles two tax years may also have tax benefits — as it may be treated as an “installment sale.” An investor can qualify for installment sale treatment if there is a “bona fide intent” to complete the exchange and the exchange falls over two tax years. In these circumstances, you can report cash not reinvested in replacement property as an installment sale in the tax year in which the exchange ends.
Spring is the perfect time for investors and homeowners to explore new opportunities, think strategically about the rest of the year, and make the most of their real estate investments. With careful planning, a 1031 exchange can be a powerful tool to maximize financial gains and set the stage for long-term success.