How to Use a 1031 Exchange to Purchase Investment Property in Austin, TX
If you’ve been in the property investment business for more than 15 minutes, you’ve probably heard of Section 1031 “like-kind” exchanges. It’s a powerful tool to defer capital gains taxes when you sell an investment property and reinvest in another. The benefit here is that you can leverage your deferred taxes to scale your portfolio or reposition into better markets. But, as with many things associated with the IRS, there’s some smoke and mirrors surrounding the subject, and many would-be growing investors are left confused. We’re going to give you the skinny: how you can use a 1031 exchanges, the pros and cons, and why current mortgage interest rates might make now an especially good time to move in.
What is a Section 1031 Exchange?
A 1031 exchange (named after Section 1031 of the Internal Revenue Code) allows an investor to defer paying capital gains tax on the sale of an investment or business use real property, provided the proceeds are reinvested in a “like-kind” property. IRS+2Investopedia+2
Key features:
- Like-kind property: the relinquished property (what you sell) and the replacement property (what you buy) must both be real property used for business or investment. Personal residences, vacation homes (unless converted and meeting certain criteria) don’t generally qualify. IRS+1
- Time limits: after you sell the relinquished property, you have 45 calendar days to identify replacement property, and you must complete the purchase of the replacement property within 180 days. No extensions except in very unusual, disaster-declared cases. IRS+2American Bar Association+2
- Reporting: You’ll need to fill out IRS Form 8824 in your tax return, to report the exchange and show your deferral of gain. IRS+1
Pros & Cons of Using a 1031 Exchange
Before you commit, it’s critical to know the good, the bad, and the ugly:
Pros
- Tax Deferral
The primary benefit is deferring capital gains tax, which might be substantial depending on how much the property has appreciated. That frees up more capital to reinvest. Investopedia+1 - Portfolio Growth & Repositioning
You can move from one property to another (for example, older, higher-maintenance into newer, more efficient; or move from one neighborhood to another; or shift types — maybe from single-family to multi-unit) without incurring tax drag at each step. - Leverage & Debt Strategy
You can manage your debt (mortgage) structure via the exchange, perhaps improving leverage, moving to properties with better cash flow, or in markets with stronger appreciation potential. - Step-Up in Basis at Death
Deferred gains under 1031 can be eliminated if you hold the property until your death, because heirs get a “step-up” in tax basis. However, that depends on estate planning. Stessa
Cons / Risks
- Strict Rules & Deadlines
Missing the 45-day identification period, or the 180-day closing period, will typically void the deferred gain benefit. These deadlines are rigid. American Bar Association+1 - “Boot” & Partial Taxable Gain
If you receive non-like-kind property or cash (called “boot”) in the exchange, that part may trigger recognition of gain. Also, if the replacement property has less debt or costs than the relinquished property, you may have to bring in cash or take on debt to avoid taxable gain. American Bar Association+1 - Liquidity & Opportunity Cost
Because you’re tying up proceeds into another property rather than receiving cash, you lose flexibility. Also, property you pick next may have different risks (maintenance, vacancy, local laws, etc.). - Complexity & Cost
You’ll need a Qualified Intermediary (QI) to handle the exchange, legal & closing costs, sometimes increased due diligence. It’s more complicated than a straight sale. - Market Risk
If you pick a replacement property that underperforms, or if market conditions change (e.g. interest rate hikes, property tax increases, neighborhood decline), your expected returns may not materialize.
Steps to Obtain a 1031 Exchange (Especially Relevant in Austin, TX)
If after weighing pros and cons you're interested in doing a 1031 exchange in Austin, here’s a logical step-by-step guide:
- Confirm Eligibility
- Make sure your current (relinquished) property is held for investment or business, and that what you’ll be buying (replacement property) also will be used for investment or business. IRS+1
- Ensure neither property is property held “primarily for sale” (i.e. inventory) or personal residence (unless converted under certain rules).
- Select & Engage a Qualified Intermediary (QI)
You cannot directly receive the sale proceeds from the relinquished property. A QI holds the funds and handles the exchange mechanics. This is required by IRS rules.
- Sell the Relinquished Property
Close the sale, transfer the property per ordinary real estate deal. The 45-day clock starts on the date the sale is “closed” (technically, when the deed transfers, depending on the structure).
- Identify Replacement Property (within 45 days)
From the sale date you have 45 calendar days to identify potential replacement properties. The identification must be in writing, using a legal description or distinguishable name, and often sent to the QI. You can identify up to three candidates (three-property rule), or more under the “200% rule” (where the total value of identified properties cannot exceed 200% of the value of the relinquished property unless you end up acquiring at least 95% of the value of identified ones). American Bar Association+1
- Close on the Replacement Property (within 180 days)
From the closing of the relinquished property, you have up to 180 days (or until your tax return is due with extensions, whichever is earlier) to acquire the replacement property. IRS+2American Bar Association+2
- Report the Exchange to the IRS
Use IRS Form 8824 when you file your tax return for the year in which the relinquished property was sold. Disclose the relinquished property, the replacement, what funds were handled through the QI, any boot, and compute the deferred gain and basis of new property. IRS+1
Why Now Might Be a Good Time: Mortgage Rates & Austin’s Real Estate Appeal
To make the financials of this make sense, interest rates on mortgages are a big piece of the puzzle — your borrowing cost influences your cash flow, your cap rate, and returns.
- As of mid-September 2025, the average U.S. 30-year fixed mortgage rate has dropped to around 6.35% (Freddie Mac) from higher rates earlier in the year. FRED+2Mortgage News Daily+2
- Some reports show rates in the low to mid-6% range, with recent weekly drops of 15 basis points, easing pressure for buyers. Reuters+2Freddie Mac+2
In Austin, TX, where housing demand remains relatively strong, this drop in rates can improve yield on rental properties. Lower interest means lower mortgage payments, which can improve cash flow, make debt service more manageable, and enhance the return on your leveraged capital. If you can lock in a rate now before any potential rate hikes or market tightening, that gives you a margin of safety.
Also, Austin has been attractive for many investors because of strong population growth, tech-sector expansion, a favorable business climate, and demand for rentals. So the combination of good market fundamentals plus more favorable financing makes investing via 1031 more compelling relative to other times.
Example: How a 1031 Might Play Out in Austin
Here’s a simplified hypothetical:
- You own a rental duplex in Dallas you bought years ago. You sell it for $500,000, your adjusted basis is $300,000, so you have $200,000 of taxable gain.
- Instead of paying capital gains tax, you use a 1031 exchange to buy a replacement property in Austin, say a 4-unit building for $600,000. You work with a QI, identify that building within 45 days, close within 180 days.
- Because you defer the capital gains, more of your capital stays invested. If mortgage rates are, say, ~6.35% fixed, your debt service might be reasonable, especially if rent in Austin is rising.
- A local property management team takes over operations: collects rents, deals with maintenance, ensures occupancy. You end up with more income, potential appreciation, and defer taxes until you eventually decide to cash out (or pass on to heirs).
Potential Pitfalls Specific to Austin & Things to Watch
- Housing market & competition: some neighborhoods in Austin are very hot. So replacement properties that meet your criteria (good cap rate, condition, location) may be in high demand. That can push up prices, reduce yield.
- Property taxes & regulation: Texas doesn’t have state income tax, which is good; but property taxes in Travis County and city of Austin can be high. Also, some areas have code or zoning challenges. Factor those into your cash flow models.
- Maintenance & wear: older properties may require significant capital expenditure. If you buy a property that looks inexpensive but needs roof, plumbing, or other major work, those costs can eat into your returns.
- Interest rate risk: even though rates have dropped somewhat, the risk remains that rates could increase, tightening your debt service or making refinancing more expensive in the future. Always build in cushion.
What the IRS & Major Financial Institutions Say
- The IRS plainly states that 1031 exchanges are permitted “only to real property” held for business or investment; not for personal residences or property held primarily for sale. IRS+1
- The IRS requires strict adherence to deadlines: 45 days to identify replacement, 180 days to acquire. IRS+1
- Major sources like Investopedia describe that besides deferring capital gains, you need to avoid boot, replace the equity and debt structure appropriately to maximize the benefit. Investopedia+1
- On mortgage rates: Freddie Mac reports the 30-year fixed rate at ~6.35% as of September 11, 2025. FRED+1
Is It Worth It for You?
You’ll need to run the numbers for your specific situation:
- Estimate after-tax gain if you sold without 1031 vs deferred gain using 1031.
- Estimate net cash flow of replacement property (rent minus mortgage, taxes, insurance, maintenance, vacancy). Use current Austin rental market data.
- Factor in the cost of property management in Austin, TX: fees (often a percentage of rent), turnover, repairs. Good property management can make or break net yields.
It’s at least worth having a tax advisor model your specific case if you think a 1031 exchange might work for you. Finding local experts (real estate brokers familiar with investment property, a strong property management firm, a QI, an accountant) will help avoid pitfalls should you decide to move forward.
If you’re interested in purchasing an investment property, or you’d like to put your current portfolio in expert hands, Neighborhood Realty and Property Management has been one of the top-producing rental property management companies in the Austin area for more than 30 years. We’d love to help you reach new levels of success!