Keep One Property, Exchange the Rest: Pruning a Portfolio With Serial Exchanges

Choose the keeper on management, debt and future use, because the tax treatment is nearly symmetrical

It is tempting to keep the property with the lowest basis because it has the biggest gain. But an exchanged property also keeps its gain deferred, and section 1014 resets basis to fair market value at death for property you hold directly or through replacement property. Basis alone rarely decides it.

What does differ is the work and the risk. Keep the property you could manage from anywhere, that carries little or no debt, and that you would struggle to buy again in its location. If you might move into one property later, keep that one: under section 121(d)(10), a property acquired in an exchange cannot use the home sale exclusion until five years after you acquired it, so moving into a replacement is slower than moving into a property you already own.

Sentiment is a legitimate reason too, as long as you know what you are paying for it in management time and concentration.

Sequence the sales so each one gets its own clock

You can sell the properties you are letting go of as separate exchanges or as one. If several relinquished properties are part of the same deferred exchange and close on different dates, Reg. section 1.1031(k)-1(b)(2)(iii) runs the identification and exchange periods from the earliest transfer. The third sale might arrive with only weeks left to identify.

Separate exchanges give each sale its own 45 and 180 days and its own identification list of three properties or up to 200% of that sale's value. They also mean separate exchange agreements and a Form 8824 for each; Form 8824 with multiple properties and DSTs covers the reporting.

One exchange of several properties makes sense when they close close together and you want one larger replacement whose price needs all the proceeds. Several properties into one covers that structure, and consolidating rentals into one covers the decision to end with a single building.

Put an exchange cooperation clause in each sale contract so every buyer agrees to the assignment to your intermediary, and list the properties in the order you want them to close. A buyer who insists on a fast closing can pull one sale ahead of the others, which matters only if they are in one combined exchange; see the exchange cooperation clause.

Selling one rental for cash can release suspended passive losses, but only if it is its own activity

Publication 925 allows suspended passive losses in full when you dispose of your entire interest in a passive activity in a fully taxable transaction to an unrelated person. An exchange is not fully taxable, so losses on exchanged properties stay suspended.

If your rentals are separate activities, selling one weaker property for cash can release its losses to offset part of the gain. If you grouped them as one activity, Publication 925 says disposing of one is only part of your interest, and nothing is released until the last one goes. Check how your returns treat them; the grouping election and suspended losses and a 1031 explain both cases.

Worked model: four rentals, keep one, exchange three into DSTs on separate clocks

Hypothetical round numbers. Your properties, debt and timing will differ, so run your own numbers with your CPA.

• Rentals A, B, C and D. Keep A: paid off, ten minutes from home, a candidate for a child to live in later.
• B sells in March for $500,000 net with a $150,000 loan. C sells in May for $450,000 net with no loan. D sells in June for $350,000 net with a $100,000 loan. Each is its own exchange with its own 45 and 180 days.
• To defer all gain, B's replacements must total at least $500,000 with $150,000 of debt or added cash; C's at least $450,000; D's at least $350,000 with $100,000 of debt or cash.
• Each exchange buys interests in two or three DSTs whose allocated loans cover the debt, and each identifies backups within its own 200% limit. Had all three been one exchange, every identification would have been due 45 days after the March sale.

DSTs suit the properties you let go, and the kept rental stays the one you manage

DST interests are real property for exchange purposes under Rev. Rul. 2004-86, arrive with financing and management in place, and can be bought in amounts that match each sale. Our traditional DST offerings typically take $100,000 to $250,000 per trust and often close in three to five business days, which helps when three sales land close together. Distributions are not guaranteed, interests are illiquid, and the sponsor decides when each property sells.

If you would rather own a whole property you never manage, a direct title security holds a triple-net-leased single-family rental in your own single-member LLC. The tired landlord's exit covers the wider move from active to passive.

The rental you keep stays an ordinary Schedule E property with its own depreciation schedule and its own passive results. The $25,000 rental loss allowance explains when a loss from it can offset other income, which matters more once the other rentals have been replaced by passive DST interests.