How a home you never meant to keep can become the foundation of a real estate investment strategy — and why the planning starts long before you list it.
EJF Rentals • Owner Education Series • Washington DC · Maryland · Northern Virginia

If you had told many of our clients five or ten years ago that they would eventually become real estate investors, they probably would have laughed.

They bought a home because they needed somewhere to live. They found a neighborhood they liked, saved for a down payment, navigated the mortgage process, survived the inspection and appraisal, and finally got the keys.

They were homeowners.

Then life happened.

Maybe they got married and moved into a larger home. Maybe a job took them to another city. Maybe they inherited a property. Maybe they decided they wanted to move closer to family. Or perhaps they simply bought another home and couldn't quite bring themselves to sell the first one.

So instead of selling, they rented it.

And just like that, they became what I often refer to as the accidental landlord.

This is a very common path into real estate investing. In fact, many of the owners we work with did not set out to build a rental portfolio. They simply made a decision that made sense at the time: Rather than sell the house, let's see if we can rent it.

Over time, however, that decision can create something much more significant.

You now own an investment property.

And once you begin thinking of that property as an investment rather than simply the house you used to live in, a whole new set of questions starts to emerge.

Should I keep it?

• Should I sell it?
• Should I buy another property?
• Should I use the equity to invest somewhere else?
• What happens to the taxes if I sell?

And eventually, someone may mention two words that you have probably heard before but never thought applied to you: 1031 Exchange.

At its most basic level, a 1031 exchange is a provision of the federal tax code that can allow an investor to defer paying capital gains taxes when they sell certain investment or business real property and reinvest the proceeds into another qualifying property.

The important word here is defer.

A 1031 exchange generally isn't a way to make the tax disappear. Instead, it can allow an investor to postpone recognizing certain taxable gains by moving the investment from one qualifying property into another.

And that distinction matters.

The concept is relatively straightforward:

But the rules surrounding a 1031 exchange are anything but casual.

There are specific requirements involving the properties, timing, identification of replacement property, how proceeds are handled and who facilitates the transaction.

That is why a 1031 exchange is something to plan before selling—not something to start thinking about after the closing.

And for the accidental landlord, that planning can become particularly important.

This is where things can get interesting.

A property does not necessarily have to have been purchased as an investment property from day one for it to eventually become part of your investment strategy.

Consider a common example.

You purchased a condo in Washington, DC as your primary residence. You lived there for several years. Eventually, you purchased another home and decided to rent out the condo rather than sell it.

For years, it may have simply been “my old home that I rent.”

But from an investment perspective, things have changed.

You now have a rental property producing income. You have tenants. You have expenses. You have a property manager. You are tracking income and expenses. And, importantly, you now have an asset that may appreciate over time.

Five years later, perhaps the condo is worth substantially more than you originally paid.

At that point, you may find yourself asking whether continuing to own that particular property is actually the best use of your capital.

Maybe the condo has appreciated significantly, but you don't love the building anymore. Maybe the rental economics aren't as attractive as they once were. Maybe you want to move from a single condo into a small multifamily property. Maybe you want to invest in another market. Or perhaps you simply want to consolidate several smaller investments into one larger property.

This is where understanding the concept of a 1031 exchange can become valuable.

One of the biggest mindset shifts I see with accidental landlords is the realization that becoming a landlord doesn't have to be the end of the story.

It can be the beginning.

The home you purchased as a first-time buyer may eventually become your first investment property. That investment property may eventually become the source of equity for your next investment. And the next investment could potentially be something completely different.

That transition doesn't happen overnight, and it certainly doesn't happen for everyone.

But once you recognize that you have an investment asset, you can start asking different questions about what that asset can do for you.

That's one of the conversations we like to have with our owners.

We aren't simply managing the property and collecting rent. We're looking at the bigger picture.

• How is the property performing?
  • What is happening with rents?
  • What is happening with expenses?
  • What is the property's approximate market value?
  • How much equity may have accumulated?
  • What are your long-term goals?

And perhaps most importantly: Does this property still make sense for you?

This is where I think the 1031 conversation gets particularly interesting.

When people hear “sell an investment property,” they often think the conversation is simply about listing the property, finding a buyer and collecting the proceeds.

But an investor should be thinking several steps ahead.

If you sell an investment property that has appreciated significantly, there can be tax consequences associated with that sale. Depending on the circumstances, those consequences can affect how much capital you actually have available to reinvest.

A properly structured 1031 exchange may allow an investor to keep more of that capital working in real estate rather than immediately paying taxes on the gain.

That potentially creates an opportunity to reposition wealth rather than simply cash it out.

• Could that be a larger multifamily property?
  • Could it be several properties?
  • Could it be a property in a different market?
  • Could it produce better cash flow?
  • Could it better fit the investor's long-term estate or retirement objectives?

Those are much more interesting questions.

And they are questions worth exploring before putting the property on the market.

This is also where I need to make an important distinction.

As a property manager and real estate broker, I can help an owner identify opportunities, evaluate properties from a real estate perspective and connect the dots between an existing rental property and potential future investments.

But I am not an accountant or an attorney.

And neither should your property manager or real estate agent be the person making your tax or legal decisions.

A 1031 exchange has very specific requirements. There are deadlines and structural requirements that need to be followed. The transaction generally involves a qualified intermediary, and the proceeds cannot simply be handed to the seller to do whatever they want with them.

There are also important distinctions regarding what qualifies as like-kind real property, how replacement properties are identified and what happens when an investor receives cash or other non-qualifying property as part of a transaction.

And there are additional considerations when you are dealing with a property that was once your primary residence.

This is where your tax advisor, CPA, attorney and other appropriate professionals need to be involved.

If there is one thing I hope owners take away from this conversation, it is this:

Don't wait until you've accepted an offer to start asking about a 1031 exchange.

By then, some of the most important planning decisions may already have been made.

If you are considering selling a rental property, start the conversation early.

• Talk to your accountant.
  • Talk to your attorney.
  • Talk to a qualified intermediary.
  • And talk to your real estate professional about what you might want to acquire next.

The question shouldn't simply be, “What can I sell my property for?”

It should also be:

“What do I want my real estate portfolio to look like after I sell?”

That is a much more strategic question.

This is ultimately why I think the 1031 exchange is such a useful topic for our clients.

Most people don't wake up one morning and decide, “Today I'm going to become a real estate investor.”

It usually happens incrementally.

You buy your first home. You build equity. Life changes. You move. You rent the old property. The property appreciates. You realize you now own an investment.

And eventually, you begin thinking less about the house you bought years ago and more about the wealth-building opportunity it represents today.

That is when the conversation changes.

A rental property is not just a property that needs a tenant.

It is an asset. And like any other investment, you should periodically ask whether it is still doing what you want it to do.

Maybe the answer is yes. There is absolutely nothing wrong with keeping a property that continues to perform well and fits your financial objectives.

But maybe the answer is no.

Maybe there is a better opportunity. Maybe you have accumulated enough equity to move into a different type of investment. Maybe you want to grow.

And maybe a 1031 exchange could be one of the tools that helps you get there.

This is going to be the first in a series of conversations about 1031 exchanges because there is a lot more to understand. We'll dig into some of the terminology, the basic mechanics of an exchange, the timelines that investors need to understand, what happens when you sell a property that was once your primary residence, and some of the common mistakes investors make when they approach a 1031 exchange.

The goal isn't to turn you into a tax expert. It is to make you a more informed real estate investor.

Because that's really where we see our role as a property manager and real estate broker extending beyond the day-to-day management of your rental property. We want our owners to understand the opportunities that exist around the asset they already own.

Sometimes that means improving the property's performance. Sometimes it means adjusting the rent. Sometimes it means refinancing, renovating or simply holding.

And sometimes, the right answer may be selling one property and moving that equity into another.

A 1031 exchange may or may not be part of that strategy.

But if you have gone from first-time homebuyer to accidental landlord, it is a conversation you should at least know exists.

Because the property you never intended to become an investment may ultimately become one of the most important pieces of your long-term real estate strategy

And that is where accidental landlords can start becoming intentional investors.

This article is intended for general educational purposes only and is not tax, legal or financial advice. 1031 exchanges involve complex rules and timing requirements. Property owners should consult with their CPA, tax advisor, attorney and qualified intermediary to determine whether a 1031 exchange is appropriate for their individual circumstances.