Navigating the Challenges of Rental Ownership: How a 1031 Exchange Can Help You Transition

Owners of rental properties or vacation rentals might be feeling the pressures of today’s shifting market. While investing in real estate remains a strong strategy for building wealth, managing properties requires a significant amount of time and effort, and rising taxes, changing regulations, increased management costs and saturated markets have made it even more challenging.

For those considering selling, now is a prime time to explore the benefits of a 1031 exchange, which allows the deferment of capital gains taxes. Plus, investing with a reputable multifamily real estate sponsor through a 1031 enables sellers to continue to enjoy the financial benefits of real estate ownership without the hassle of hands-on management.

Among the pressing challenges currently facing rental property owners:

1. Market Saturation for Short-Term Rentals: So far in 2024, the U.S. vacation rental industry has experienced a continued decline in performance, although at a slower pace than 2023. Occupancy levels have slightly decreased compared to last year, driven by rising supply and softer demand. While rates have remained relatively stable, overall revenues have seen a modest decline. According to AirDNA, occupancy rates for STRs have dropped by 4% year-over-year, reaching only 49.8% as of September. Revenue per available rental declined 1.6% year-over-year to $146.09. As economic conditions evolve, STR demand may continue to slow, leading many owners to question whether now is the right time to sell and reinvest in more stable opportunities.
2. Increasing Management and Insurance Costs: Managing rental properties has become increasingly costly. If you use a property management company to help with your rentals, fees can range from 10% to 30% of gross income. Additionally, rising insurance premiums and property maintenance costs place additional financial burdens on owners, particularly those with properties in high-risk areas. For many, the responsibilities and expenses of property management now outweigh the potential benefits.
3. Stricter Regulations: Rental property regulations and discussions around affordable housing and renter protections are continuously evolving. For STR owners, regulations often involve occupancy limits, mandatory permits and caps on rental nights. For example, cities like New York and Los Angeles have enacted measures that have significantly reduced short-term listings. Compliance with these regulations adds complexity and cost for property owners, which can make doing a 1031 exchange and reinvesting with a multifamily real estate sponsor a more attractive option. Investors are still able to invest in real estate without having to follow and respond to regulations personally.

Even with the challenges that come with managing rental properties, real estate remains an essential component of a well-balanced portfolio. A 1031 exchange can provide investors with a way to optimize their portfolios while avoiding the stresses and strains of being a property manager.

The Benefits of a 1031 Exchange

A 1031 exchange with a reputable multifamily sponsor offers a tax-efficient way to transition from active property management to a more passive, diversified investment. Here are the benefits such a transaction provides:

• Defer Capital Gains Taxes: Selling a property with a low basis without using a 1031 exchange for a like-kind asset can result in substantial capital gains taxes. Long-term capital gains taxes can be up to 20%, and high-earning individuals may also need to account for the net investment income tax (NIIT), an additional 3.8% tax that can be triggered if income exceeds a certain limit. With a 1031 exchange, however, sellers can defer these taxes by reinvesting the proceeds in a “like-kind” property. This creates the ability to reinvest the full value of their equity, providing more wealth-building funds to grow wealth over time through appreciation and income.
• Shift from Active Management to Receiving Passive Income: Transition from hands-on property management to passive ownership by reinvesting in a multifamily sponsor with professionally managed properties. This allows investors to enjoy a steady stream of truly passive income.
• Greater Diversification: A 1031 exchange with a sponsor creates a diversified portfolio by investing in institutional-quality properties across high-growth markets. This reduces reliance on one market and mitigates exposure to local regulations by spreading investments across multiple locations.
• Professional Property Management: Reinvesting with a reputable sponsor gives investors access to professional property management services. This shifts the focus to building wealth and achieving financial goals without the demands of active management.

The decision to sell a rental property can be challenging, but current market conditions, regulatory changes, and rising costs create a compelling case for exploring new investment strategies.

This article was originally published in the April 2025 issue of Family Office Real Estate Magazine.