If you’re investing in multifamily or rental properties, the 1031 exchange is a great strategy to know. It allows you to sell one investment property and defer capital gains taxes by reinvesting into another like-kind property. That means more equity stays in play—helping you grow your portfolio faster and more efficiently.

Many of my investor clients use this tool to scale up from smaller rentals to larger multifamily buildings or diversify across different markets. Just be aware: there are strict timelines and rules, so make sure you’re working with a qualified intermediary and have a clear plan before you sell.

Want to learn more? Here are a few helpful resources:

• IRS – Like-Kind Exchanges (1031)
• Investopedia – 1031 Exchange Overview
• IPX – 1031 Exchange Highlights

Here’s a simple scenario to show how it works:

You purchased a rental home for $500,000 and spent $150,000 in renovations. If the land value is $200,000, the depreciable value of the building is $450,000. Depreciation is calculated over 27.5 years, which gives you a yearly deduction of about $16,364. That means if your rental income is $36,000 per year, your taxable rental income is reduced to about $19,636—before factoring in other expenses.

Even better, this year 2025, there’s a 40% bonus depreciation, which allows you to deduct a large portion of the property’s cost upfront when you purchase it.

After renting for five years, you sell the home for $1,500,000. I’ll walk you through how to calculate capital gains taxes in this case and how a 1031 exchange can help you defer those taxes entirely.

Basic Info:

• Purchase Price: $500,000
• Renovation Cost (Capital Improvements): $150,000
• Land Value (non-depreciable): $200,000
• Rental Period: 5 years
• Sale Price: $1,500,000

 Step-by-Step Calculation:

1. Adjusted Cost Basis (Excluding Land Depreciation)

• Total cost: $500,000 + $150,000 = $650,000
• Depreciable basis = $650,000 – $200,000 = $450,000
• Annual depreciation: $450,000 ÷ 27.5 = $16,364
• Total depreciation over 5 years: $16,364 × 5 = $81,818
• Adjusted basis = $650,000 – $81,818 = $568,182

2. Capital Gain Calculation

• Sale Price: $1,500,000
• Adjusted Basis: $568,182
• Capital Gain = $1,500,000 – $568,182 = $931,818

3. Capital Gains Tax Estimate

Type	Amount	Tax Rate	Estimated Tax
Depreciation Recapture	$81,818	25%	≈ $20,455
Long-Term Capital Gain	$850,000	15–23.8%*	≈ $127,500–$202,300

Note: Depreciation Recapture: The IRS allows you to depreciate the building over time to reduce your taxable income during the years you own the property. However, if you sell the property, the IRS wants you to pay 25% of the tax benefit you received from that depreciation. 

Summary

• Total gain: ~$931,818
• Taxes owed (estimate):
  • Depreciation recapture: ~$20,455
  • Capital gains tax: ~$127,500–$202,300
  • Total tax: ~$147,955–$222,755

Depending on your income bracket, your capital gains tax could range from $147,955 to $222,755—a substantial amount going to the government. That’s why, if you don’t need the cash right away, a 1031 exchange can be a powerful strategy to build wealth.

Instead of paying taxes, you could reinvest that money into another income-producing property. For example, if you purchase a $1.5 million property with a cap rate of 5% to 10%, your net operating income could range from $75,000 to $150,000 annually. That means, in just two years, you could generate as much income as the taxes you would’ve paid—plus you still own the property.

Here’s the important part:
You can continue deferring capital gains taxes as long as you keep reinvesting through 1031 exchanges. However, once you sell the property without doing another exchange, you’ll owe taxes based on the 

original adjusted basis (in the scenario above, $568,182), plus improvements, minus depreciation taken—so the gain could be significant.

But if you pass the property to your heirs, they receive a step-up in basis to the market value at the time of inheritance. This means they’ll only pay capital gains on any future increase beyond that value, potentially saving your family a large tax bill.

If you’re thinking about selling or buying investment properties, I’d be happy to help you explore your options and see if a 1031 exchange is right for your situation.Feel free to reach out anytime!

— April Jeong-Callies, Real Estate Broker
Specializing in Multifamily, Investment, and Waterfront Properties across Puget Sound