Can I Do a 1031 Exchange When Downsizing? Yes, But There’s a Catch

Most articles about 1031 exchanges focus on scaling up, but what if you’re ready to simplify your portfolio? Maybe you’re looking to reduce management responsibilities, shift to a more passive investment strategy, or just right-size your investments for your current stage of life. Let’s explore how a 1031 exchange might still work for you.

The Short Answer

Yes, you can use a 1031 exchange when downsizing, but here’s the key point: any equity not reinvested will be taxable. This is known as “boot” in 1031 exchange terminology.

Smart Strategies for Downsizing

1. Consider Multiple Properties
   1. Split your exchange into smaller, more manageable properties
   1. Maintain full tax deferral while reducing individual property management burden
   1. Example: Exchange one large apartment building for several smaller rental homes
2. Explore Delaware Statutory Trusts (DSTs)
   1. Invest in professionally managed properties
   1. Maintain your equity position while reducing personal involvement
   1. Often available at lower minimum investment amounts
3. Property Type Conversion
   1. Switch from management-intensive properties to lower-maintenance options
   1. Example: Exchange a multi-unit building for a single-tenant NNN lease property
   1. Maintain value while reducing management responsibilities

Making Boot Work for You

If you decide to take some boot (taxable proceeds), consider:

• Timing the exchange for a year when you have losses to offset gains
• Using the extra capital for property improvements on your replacement property
• Exploring installment sale options to spread the tax impact

The Bottom Line

Downsizing through a 1031 exchange is absolutely possible—it just requires careful planning and potentially accepting some tax consequences if you’re reducing your total investment value. The key is determining whether the benefits of downsizing outweigh the potential tax impact of boot.

Ready to explore your downsizing options with a 1031 exchange? Don’t go it alone. Call us at 888-508-1901 for a consultation. Our team at WealthBuilder 1031 can help you evaluate different strategies and find the approach that best balances your desire to downsize with your tax objectives.