A 1031 exchange allows an investor to sell an apartment building, reinvest the proceeds into other like-kind real estate, and defer capital gains tax, as long as replacement properties are identified within 45 days and the purchase closes within 180 days. In an exchange, the property you sell is referred to as the downleg and the property you buy is the upleg.
I have personally closed more than $4 billion in commercial real estate transactions, primarily multifamily across the Bay Area, including Silicon Valley, the Peninsula, and the East Bay. Our team has closed more than $9 billion in total, and the majority of those deals were part of a 1031 exchange. I’ve also been on the other side of the table: as the owner of a current portfolio of more than 120 apartment units, I have used 1031 exchanges myself.
What has that experience taught me? The tax deferral is the reason most owners consider a 1031 exchange. What makes one successful is knowing what the proceeds need to become: more units, a better location, less management, or a different kind of income. This playbook covers the rules, the ways our clients use exchanges, and the mistakes to avoid.
What Are the 1031 Exchange Rules?
- Real estate for real estate. Both the property you sell and the one you buy must be held for investment or business use. Within that, “like-kind” is broader than most owners expect.
- Don’t touch the money. You never have access to the sale proceeds. A qualified intermediary, an independent third party, holds them and sends them directly into your replacement purchase. If the cash reaches your account first, even briefly, the exchange can be disqualified.
- 45 days to identify, 180 days to close. Both clocks start when the downleg closes, and neither one pauses.
- Trade equal or up. To defer all of the gain, the replacement should cost at least as much and carry at least as much debt, or new cash is added to make up the difference. Anything you keep or don’t replace, known as boot, is taxable.
How Are Bay Area Owners Using 1031 Exchanges?
Scaling up in a submarket they already know
Some owners think of growth as entering a new market. Often the answer is actually building the portfolio just a few doors down. This year, one Levin Johnston Client in Livermore completed two exchanges with our team: Outrigger Apartments (42 units) into Royal Gardens and Alderwood Park, two communities across the street from each other (91 units), and Pacific Apartments (20 units) into Briarwood Apartments (64 units). Sixty-two apartment units became 155, with new depreciation and no unfamiliar risk.
The Client already knew Livermore well, and that knowledge is what made the move low risk. Employment is anchored by Lawrence Livermore National Laboratory, Sandia National Laboratories, and Stanford Health Care, and median household income exceeds $150,000. Prior ownership had also done much of the heavy lifting: more than $2.3 million in capital improvements at Briarwood and a combined $1.4 million at Royal Gardens and Alderwood Park. The Client achieved scale without taking on a renovation program.
Moving capital to a stronger market
A Levin Johnston Client sold The Colony House, a 34-unit apartment community in Sacramento, for $5.6 million and less than three weeks later closed on Alamo Park, a 33-unit apartment community in Mountain View, for $12.1 million. Nearly the same unit count, but now just a mile from OpenAI’s recently leased 450,000 square-foot office, in a submarket where older apartments run below 2.5% vacancy. Value creation at The Colony House depended on renovating unit by unit. At Alamo Park, it depends on demand Mountain View already has.
The property itself helped. The prior owner had expanded it from 25 to 33 units by converting tuck-under parking and adding a new duplex, creating eight accessory dwelling units that command new construction rents with no deferred maintenance. The Client reset depreciation, improved the age and condition of the portfolio, and moved the income base into one of the tightest rental markets in the country.
Resetting depreciation by changing asset class
After decades of ownership, many Bay Area buildings have no depreciation left to give. A family we advise, which had fully depreciated a San Mateo County apartment building, exchanged into a $23.685 million medical office property in Rohnert Park, anchored by Kaiser Permanente and Petaluma Health Center. They kept the deferral and gained a new depreciation schedule and long-term healthcare leases.
The appeal was not just the tax reset. Medical office tenancy is needs based: patients keep coming regardless of where apartment rents are in the cycle. For an owner whose wealth was concentrated in Bay Area multifamily, that made the exchange a diversification move as much as a tax move.
Trading management for passive income
Some owners are done with the late-night maintenance call. A family trust we represented exchanged a 15-unit apartment building in Palo Alto and a 20-unit apartment building in San Mateo into two Florida properties on long-term triple-net leases, a Primrose School and a dental office, for $10.08 million. The tenants carry the expenses, both leases have annual increases, and the trust’s cash flow rose 40%.
The Primrose School location came with 17 years remaining on an absolute triple-net lease. The family also already knew Florida, having owned residential property there before. Familiarity matters even when the asset is passive.
Is 45 Days Enough Time to Find a Replacement Property?
Often not, if you wait until the sale closes to start looking. Good replacement buildings in the Bay Area are scarce, especially in Silicon Valley. According to Marcus & Millichap data, the San Jose metro is expected to add roughly 150 apartments this year, among the least new supply of any major U.S. market. The well-located buildings an exchange buyer wants don’t sit on the market waiting, and sellers can tell when you’re on the clock. That’s why we work backwards: find the upleg first, then sell the downleg. It’s how Alamo Park closed less than three weeks after The Colony House.
How Should You Prepare Before Listing?
- Start the replacement search first. Ideally, your primary target is identified and underwritten before the sale goes into escrow.
- Identify backups. Most investors use the three-property rule, which allows up to three candidates of any value. A primary target and two credible alternates protect the exchange if an inspection or a lender falls through.
- Line up financing early. Because debt has to be replaced along with value, lender timelines matter as much as escrow timelines.
- Engage a qualified intermediary and a CPA before you list. Not the week of closing.
- Know when to reverse the order. If the right replacement appears before the sale, a reverse exchange lets the purchase happen first. It costs more to structure, but it can be the difference between getting the building and losing it.
What Are the Most Common 1031 Mistakes?
- Starting the search after the downleg closes. You’ve lost your leverage as the 45-day deadline looms. We don’t put Clients into the wrong assets because we find the right upleg before the downleg closes.
- Taking the proceeds. Even briefly, it can disqualify the exchange.
- Forgetting the debt. A smaller loan on the replacement, without new cash to cover it, is taxable boot.
- Treating an out-of-state exchange as a clean exit. California requires an annual Form 3840 filing and can tax the deferred gain when the out-of-state property is eventually sold.
With new supply this limited and so many longtime owners holding fully depreciated buildings, I expect the 1031 exchange to remain one of the main ways Bay Area apartment portfolios get rebuilt over the next several years. The owners who come out ahead will start with the replacement property, not the sale.
Frequently Asked Questions
How long do I have to complete a 1031 exchange?
45 days from the sale to identify replacement properties in writing, and 180 days to close, or your tax return due date if that comes first.
Can I exchange an apartment building for a different type of property?
Yes. Any real estate held for investment, including net-lease retail, medical office, or self-storage, qualifies as like-kind to an apartment building.
What are the upleg and downleg in a 1031 exchange?
The downleg is the property you sell, formally called the relinquished property. The upleg is the property you buy, called the replacement property. Either leg can include more than one property. The 45-day identification deadline and the 180-day closing deadline both start when the downleg closes, or when the first downleg property closes if there’s more than one. That’s why we find the upleg first.
Can I exchange one property into two, or two into one?
Yes. Our clients have done both, including one 42-unit Livermore building into two communities totaling 91 units.
Does a 1031 exchange reset depreciation?
It can. When you trade up into a more valuable property, the added value creates new depreciable basis. That is one reason owners of long-held, fully depreciated Bay Area buildings often exchange into larger or newer properties.
What is boot in a 1031 exchange?
Boot is anything you receive that is not like-kind real estate, most often cash kept at closing or a reduction in debt. Boot is taxable, even if the rest of the exchange is deferred.
Is a 1031 exchange always the right move?
No. If the only available replacement properties are ones you would not otherwise buy, paying tax on some or all of the gain can be the better long-term decision. A good advisor should be willing to tell you that.
Did the One Big Beautiful Bill Act change 1031 exchanges?
No. The law signed July 4, 2025, left Section 1031 intact. It did permanently restore 100% bonus depreciation for qualifying property acquired and placed in service after January 19, 2025. For exchange buyers, that benefit generally applies to the added value of a trade-up rather than the basis carried over from the property sold, so it is worth modeling with a CPA alongside a cost segregation study.
Can I exchange California property into another state?
Yes, but California requires an annual Form 3840 filing and can tax the deferred California gain when the replacement property is eventually sold.
This article is for general informational purposes and is not tax or legal advice. Consult a qualified tax advisor before entering into a 1031 exchange.
About the Author
Robert Johnston is Executive Managing Director at Levin Johnston of Marcus & Millichap, a leading commercial real estate advisory group, investment advisor, and brokerage team based in the Bay Area that has closed more than $9 billion in transactions to date. He consistently ranks among Marcus & Millichap’s top multifamily agents nationally and is a 10-time CoStar Power Broker.
