Anticipated increase in volume due to declining interest rates - by Brendan Greene

Internal Revenue Code (IRC) Section 1031 allows a property owner, who holds property for “the productive use in a trade or business or for investment” to defer paying capital gains taxes if the property owner sells such property, identifies “like kind” property within forty-five days of the sale, and acquires “like kind” property within one hundred eighty days of the sale.

The 2026 forecast for 1031 exchanges is generally positive. Market experts predict a general increase in real estate transaction volume, including 1031 exchanges, driven by an anticipated reduction in interest rates, the core tax deferral benefits remaining intact and not subject to any proposed changes to limits on the amount of deferred gains, many commercial loans that were taken out in 2020 and 2021 at low rates resetting in 2026 for significant higher rates, and Congress permanently restoring 100% bonus depreciation. 

The expected easing of rates will make financing replacement properties less expensive, stimulating activity for investors who have been on the sidelines. Investment activity has been steadily climbing over the past five plus years, even during market uncertainty. While overall real estate transactions dropped 22.1% between 2019 and 2023, 1031 exchanges increased by 15% according to analysis from 1031 CORP. Furthermore, despite periodic proposals to cap or eliminate Section 1031 exchanges, the 2025 legislative landscape brought renewed certainty when the One Big Beautiful Bill Act preserved 1031 exchanges without the proposed $500,000 cap, giving investors confidence to continue using the wealth building strategy. With increased transaction volume and a shift toward passive investment in real estate, vehicles such as Delaware Statutory Trusts (DSTs) have never been more relevant.

Real estate investors who secured five-year adjustable-rate mortgages (ARMs) at record-low rates (often under 3%) in 2020 and 2021 face significant payment shocks in 2026 as their loans reset to higher prevailing rates, projected to be around 6%. Many investors used 5/1 ARMs, meaning they had a fixed rate for five years and will see their first adjustment in 2026. This “reset cliff” directly impacts 1031 exchange activity by altering debt requirements (debt replacement) and limiting borrower purchasing power, forcing many investors to sell, refinance or restructure their portfolios. For instance, a $1 million loan at 2.75% has a principal/interest payment of roughly $4,080. If that rate resets to 6.5%, the payment jumps to over $6,300 - a potential greater than 50% increase in debt service.

Investors facing this reset will likely turn to 1031 exchanges to escape high debt service or to rebalance their portfolios to avoid negative cash flow. The rate reset might make properties cash-flow negative, forcing investors to sell and use a 1031 exchange to move into a more profitable asset. In addition, the permanent restoration of 100% bonus depreciation is a game changer for many real estate investors. To fully understand how effective this can be let’s take a look at an example.

Consider a commercial property purchased for $5 million. Under standard depreciation rules, the building (excluding land) would be depreciated over 39 years for commercial property or 27½ years for residential rental property. That’s a methodical, slow recovery of your investment costs. 

However, not everything in a building depreciates over 39 years. Through a cost segregation study, an engineering-based analysis that identifies property components, you can reclassify significant portions of your building into shorter-life asset categories. Carpeting, appliances, specialized lighting, parking lot improvements, landscaping and many interior finishes qualify for five-year, seven-year or 15-year depreciation schedules. Let’s say that $5 million property includes $2 million in components that qualify for shorter depreciation periods. Under the old rules scheduled for 2025, you would have received 40% bonus depreciation, or $800,000 in first-year deductions. The remaining $1.2 million would depreciate over the assets’ regular recovery periods. Under the new permanent 100% bonus depreciation rules, you can deduct the full $2 million in year one. That’s an additional $1.2 million in first-year deductions compared to the old schedule.

For a high-net-worth investor in the top tax bracket (37% federal, plus 3.8% net investment income tax, plus state taxes, that additional 1.2 million deduction could save about $490,000.00 in federal taxes alone in the first year, not even including the state tax savings. Nearly $500,000 in tax savings becomes capital you can redeploy immediately - into new acquisitions or into business ventures. The permanent nature of this benefit means you can plan long-term acquisition strategies knowing this tool will be available for every future purchase. The revolution isn’t just about the size of the deduction - it’s about the certainty. For years, investors raced against phaseout deadlines, trying to time acquisitions before bonus depreciation expired.

An investor can develop a thoughtful, strategic approach to building wealth through real estate without artificial urgency. 2021 and 2022 saw historically low interest rates, which in turn caused historic demand for investment properties and 1031 tax deferred exchanges despite the high price of such properties for sale. Even though investors sometimes feel like they are swimming upstream, the last few years have been healthy for the 1031 tax-deferred exchange market. Part of the steady flow has been due to an increase in investor knowledge of 1031 exchanges and the various kinds of exchanges like reverse and improvement/construction exchanges. Also, the ability to invest in Delaware Statutory Trusts (DST’s) as replacement property has caused DSTs to become more mainstream.

In addition to the reasons listed above here are a few factors that carry over from the last few years that will aid in the continued growth of 1031 exchanges: (i) property owners facing significant capital gains taxes upon sale due to the appreciation investors real estate, (ii) the repurposing of real estate due to changes in certain segments of the real estate market, (ii) the sale of investment properties in colder climates and the purchase of investment replacement properties in warmer climates or parts of the country typically known as vacation areas, (iii) the availability of reverse and construction improvement exchanges, (iv) the ability to invest in DST’s as replacement property, and (v) baby boomer retirement and estate planning.

Market experts predict a general increase in real estate transaction volume, including 1031 exchanges, driven by an anticipated reduction in interest rates, the core tax deferral benefits remaining intact and not subject to any proposed changes to limits on the amount of deferred gains, many commercial loans that were taken out in 2020 and 2021 at low rates resetting in 2026 for significant higher rates, and Congress permanently restoring 100% bonus depreciation.

In summary, we anticipate a slight increase in volume in 1031 exchanges caused by declining interest rates, the value of 1031 exchanges in wealth building by its ability to allow investors to diversify or modify their portfolios into different asset based classes (multi-family, industrial…) and permanent restoration of bonus depreciation.

Brendan Greene, Esq., is a principal in Greater Boston Exchange Company, LLC and is a partner with McCue, Lee & Greene, LLP, Boston, MA.