A 1031 exchange should be a real estate investor’s best friend—defer capital gains tax, reinvest into bigger properties, and keep building wealth. Sounds great, right? Until something goes wrong.
Maybe you didn’t reinvest every dollar from the sale. Maybe you missed a key deadline. Or maybe you inherited a property and didn’t realize you could have avoided a massive tax bill. These mistakes aren’t just frustrating. They’re expensive.
The good news? A little planning goes a long way. If you want to keep your 1031 exchange tax-free, avoid these common pitfalls and take the right steps to protect your profits.
Why 1031 Exchanges Go Wrong and How to Fix Them
Even seasoned investors get tripped up by 1031 exchanges because the IRS doesn’t make it easy. Reinvesting into another property isn’t enough. The process has rules, deadlines, and fine print that can turn a tax break into a tax bill if you’re not careful.
Here’s where most investors go wrong:
1. Mishandling Funds: Why the IRS Calls It “Boot” and Taxes It
If you don’t reinvest 100% of your sale proceeds into the new property, the leftover amount called “boot” is taxable as capital gains.
What this means for you:
- Sell for $800,000, reinvest only $750,000? That $50,000 is immediately taxable.
- Even if you don’t pocket the extra cash, a lower mortgage balance on the new property could also create taxable boot.
How to avoid this mistake:
- Use a qualified intermediary to handle the exchange. Never take possession of the sale proceeds.
- Reinvest all funds, including the full mortgage balance, to avoid taxable income.
An Austin, Texas CPA can walk you through the process to make sure every dollar is reinvested correctly so you don’t get hit with surprise taxes.
2. Missing the Step-Up in Basis on Inherited Properties
If you inherit a rental property and decide to sell or exchange it, you could be on the hook for unnecessary capital gains tax unless you take advantage of the step-up in basis rule.
What happens if you don’t claim the step-up?
- You inherit a property your parents bought for $250,000, but it’s now worth $900,000.
- You sell or exchange it, thinking you owe tax on the $650,000 gain.
- In reality, you should only be taxed on the value increase from the day you inherited it, not since your parents bought it.
How to avoid this mistake:
- Get a professional appraisal at the time of inheritance to establish the correct fair market value.
- Work with an Austin tax accountant to report the right basis and avoid overpaying capital gains tax.
3. Ignoring Cost Segregation: Missing Out on Bigger Tax Deductions
A 1031 exchange defers capital gains tax, but it doesn’t automatically maximize your tax savings. Many investors miss out on huge depreciation deductions simply because they don’t run a cost segregation study.
Why this matters:
- Instead of depreciating the entire property over 5 years, a cost segregation study lets you write off certain components (like appliances, flooring, and fixtures) much faster.
- This accelerates your tax deductions, reducing taxable income immediately and freeing up more cash flow.
How to avoid this mistake:
- Schedule a cost segregation study immediately after acquiring your replacement property.
- If tax deadlines are tight, file an extension to allow time for the study before finalizing your return.
An Austin small business accountant can help you accelerate depreciation so you keep more money in your pocket and pay less in taxes.
How to Get Your 1031 Exchange Right the First Time
Want to make sure you don’t owe unnecessary capital gains tax on your next 1031 exchange? Follow these steps:
Step 1: Know the 1031 Exchange Rules
- Reinvest all proceeds to avoid taxable boot.
- Identify a replacement property within 45 days and close within 180 days.
- Work with a CPA in Austin, Texas to ensure compliance and maximize tax savings.
Step 2: Claim the Step-Up in Basis for Inherited Properties
- Get an appraisal at the time of inheritance to establish the correct fair market value.
- Work with an Austin accounting service to report the right basis and avoid overpaying taxes.
Step 3: Maximize Depreciation with a Cost Segregation Study
- Run a cost segregation study to increase tax deductions and boost cash flow.
- If needed, file a tax extension to allow time for the study.
Step 4: Work With a CPA Who Specializes in 1031 Exchange Compliance
- General accountants may not understand real estate tax law.
- A real estate-focused Austin, TX accountant ensures your 1031 exchange is structured correctly, so you don’t trigger unnecessary taxes or miss out on deductions.
Protect Your Profits: Don’t Let a Tax Mistake Cost You Thousands
A 1031 exchange is a powerful tax strategy, but only if done right. One mistake could mean unexpected capital gains tax, lost depreciation benefits, or missed tax-saving opportunities.
At Insogna CPA, we help real estate investors:
✔ Structure 1031 exchanges properly to defer capital gains tax.
✔ Claim the step-up in basis for inherited properties.
✔ Use cost segregation studies to maximize tax deductions.
✔ Ensure compliance with IRS rules while optimizing tax savings.
Don’t let a tax misstep eat into your real estate profits. Book a consultation today with a trusted CPA firm in Austin, Texas, and ensure your 1031 exchange works in your favor.