1031 Exchange for Self Storage: How to Defer Capital Gains When You Sell
Key Takeaways
- A 1031 exchange allows you to defer all capital gains and depreciation recapture taxes when you sell your self storage facility — as long as you reinvest into qualifying “like-kind” replacement property.
- The tax savings can be enormous: on a $3M sale with $1.5M in capital gains, a 1031 exchange can defer approximately $450,000+ in taxes.
- Strict timelines apply: you must identify replacement property within 45 days and close within 180 days of your sale.
- You must use a Qualified Intermediary (QI) — the proceeds cannot touch your hands at any point.
- “Like-kind” is broader than most people think: you can exchange self storage for apartments, retail, office, land, or any other investment real estate.
- Delaware Statutory Trusts (DSTs) offer a passive replacement option for owners who don’t want to manage another property.
- This is educational information, not tax advice. Consult a CPA and tax attorney before executing a 1031 exchange.
You’ve built a successful self storage facility. You’ve put in the years — managing tenants, maintaining buildings, pushing rates, keeping the lights on. Now you’re ready to sell.
And then your CPA tells you the tax bill.
Capital gains taxes. Depreciation recapture. State income taxes. Depending on your state, your cost basis, and how long you’ve owned the property, you could be looking at giving up 25–40% of your profit to taxes.
That’s where a 1031 exchange comes in. Named after Section 1031 of the Internal Revenue Code, this provision allows you to sell investment real estate, reinvest the proceeds into new investment real estate, and defer the taxes you would otherwise owe. Not reduce. Not eliminate. Defer — potentially indefinitely.
We’re the team behind The Storage Brief. We’ve helped numerous self storage owners navigate 1031 exchanges as part of their exit strategy, and we work closely with Qualified Intermediaries and tax advisors to make the process smooth. Here’s how it works.
What Is a 1031 Exchange?
A 1031 exchange (also called a “like-kind exchange” or “Starker exchange”) is a tax strategy that allows you to sell one investment property and purchase another investment property while deferring the capital gains taxes from the sale.
The basic concept is straightforward: as long as you reinvest the proceeds from the sale into qualifying replacement property and follow the rules, the IRS treats it as an exchange rather than a sale. No sale = no taxable event = no taxes due (for now).
The key word is defer. You’re not eliminating the tax liability — you’re pushing it down the road. The tax basis of your old property carries over to your new property. If you eventually sell the replacement property without doing another 1031 exchange, the deferred taxes come due.
But here’s the powerful part: you can do 1031 exchanges indefinitely, rolling from one property to the next, deferring taxes each time. And if you hold the final property until death, your heirs receive a “stepped-up basis” — meaning those deferred taxes may never be paid at all. That’s a generational wealth-building tool.
How Much Tax Are We Talking About?
Let’s make this concrete with a realistic example.
Scenario: You sell your self storage facility for $3,000,000. You purchased it 15 years ago for $1,200,000 and have taken $400,000 in depreciation deductions over that period.
| Component | Calculation | Amount |
|---|---|---|
| Sale Price | $3,000,000 | |
| Original Purchase Price | $1,200,000 | |
| Less: Accumulated Depreciation | ($400,000) | |
| Adjusted Cost Basis | $1,200,000 - $400,000 | $800,000 |
| Total Gain | $3,000,000 - $800,000 | $2,200,000 |
That $2,200,000 gain breaks into two tax categories:
| Tax Type | Amount | Rate | Tax Owed |
|---|---|---|---|
| Depreciation Recapture | $400,000 | 25% | $100,000 |
| Long-Term Capital Gains | $1,800,000 | 20% | $360,000 |
| Net Investment Income Tax (NIIT) | $2,200,000 | 3.8% | $83,600 |
| Total Federal Tax | ~$543,600 |
Add state income taxes (which vary — in many states, another 3–8% on the gain), and you could be looking at $600,000–$700,000+ in total taxes on a $3M sale.
A 1031 exchange defers all of it. Every dollar that would have gone to taxes instead gets reinvested into your next property, compounding and working for you.
The difference between keeping $2.3M working in real estate versus $1.6M (after taxes) is enormous when compounded over another 10–20 years.
How a 1031 Exchange Works: Step by Step
The 1031 exchange process has specific rules and timelines that must be followed precisely. There is very little room for error. Here’s the process from start to finish.
Step 1: Decide to Exchange Before You Sell
This is critical. You need to decide you’re doing a 1031 exchange before you close on the sale of your current property (the “relinquished property”). You cannot sell first, receive the proceeds, and then decide to do an exchange retroactively.
Start planning early. The moment you’re seriously considering selling, bring up the 1031 exchange with your broker, CPA, and attorney.
Step 2: Engage a Qualified Intermediary (QI)
A Qualified Intermediary is a neutral third party who holds the sale proceeds during the exchange. This is not optional — it’s a legal requirement. If the sale proceeds touch your hands (or your bank account) at any point, the exchange is disqualified and the taxes are due.
The QI must be engaged before you close on the sale. They will:
- Prepare the exchange documents
- Receive the sale proceeds directly from the closing agent
- Hold the proceeds in a segregated, insured account
- Disburse the funds when you close on the replacement property
Choosing a QI: Use an established, well-capitalized QI with experience and proper insurance. This entity is holding potentially millions of your dollars. Check for fidelity bonds, errors and omissions insurance, and a track record. Your real estate attorney or broker can recommend qualified firms.
Cost: QI fees typically range from $750 to $1,500 per exchange. Given the tax savings at stake, this is a trivial expense.
Step 3: Sell Your Self Storage Facility (Day 0)
Close on the sale of your facility. The sale proceeds go directly to the QI — not to you. Your closing instructions will specify the QI as the recipient of funds.
The closing date is “Day 0” for the exchange timeline. The clock starts now.
Step 4: Identify Replacement Property (Within 45 Days)
From the date you close on your sale, you have exactly 45 calendar days to identify potential replacement properties in writing. This identification must be delivered to the QI (or another party involved in the exchange, not your agent or attorney who is also acting as your agent in the acquisition).
The Three Rules for Identification:
You can identify replacement properties under one of three rules:
-
The 3-Property Rule: You can identify up to 3 properties of any value. This is the most commonly used rule. Most exchangers identify 2–3 properties and close on one.
-
The 200% Rule: You can identify more than 3 properties, but their total combined fair market value cannot exceed 200% of the value of the property you sold. If you sold for $3M, you could identify properties totaling up to $6M.
-
The 95% Rule: You can identify any number of properties of any value, but you must actually acquire 95% of the total identified value. This rule is rarely used because it’s extremely difficult to satisfy.
Our advice: Keep it simple. Use the 3-property rule. Identify your top 2–3 realistic candidates and focus on closing one.
The 45-day identification deadline is absolute. It does not get extended for weekends, holidays, natural disasters, or any other reason. If Day 45 falls on Christmas, your identification is due on Christmas. Plan accordingly.
Step 5: Close on Replacement Property (Within 180 Days)
You must close on your replacement property within 180 calendar days of selling your relinquished property (or by the due date of your tax return for the year of the sale, including extensions — whichever comes first).
The QI will disburse the exchange funds to close on the replacement property. The replacement property must be one of the properties you identified during the 45-day period.
Important rules for the replacement property:
- Equal or greater value. To defer 100% of the taxes, the replacement property must be equal to or greater in value than the property you sold. If you sell for $3M and buy for $2.5M, the $500K difference (“boot”) is taxable.
- All cash must be reinvested. You must reinvest all of the net equity from the sale. If you pull out cash, that cash is taxable.
- Equal or greater debt. The debt on the replacement property must be equal to or greater than the debt paid off on the relinquished property. If you had a $1.5M mortgage that was paid off at sale, you need at least $1.5M in debt on the new property (or make up the difference with additional cash).
What Qualifies as “Like-Kind” Replacement Property?
This is one of the biggest misconceptions about 1031 exchanges. “Like-kind” does not mean you have to buy another self storage facility. It means real property held for investment or business use — that’s it.
You CAN exchange self storage for:
- Another self storage facility (obviously)
- A multifamily apartment building
- A retail shopping center
- An office building
- Industrial/warehouse property
- Raw land (held for investment)
- A net-leased property (like a Walgreens or Dollar General)
- A Delaware Statutory Trust (DST) interest
- Any other real property held for investment or business use
You CANNOT exchange into:
- Your primary residence (personal use property)
- Stocks, bonds, or other securities
- Partnership interests (though there are workarounds with tenancy-in-common structures)
- Property located outside the United States (if the relinquished property is domestic)
- Property you intend to flip quickly (dealer property)
This flexibility is powerful. Many self storage owners use their 1031 exchange as an opportunity to change their investment strategy entirely. Tired of managing storage? Exchange into a triple-net-leased property where the tenant handles everything. Want to diversify? Exchange into a multifamily property in a different market.
Common Pitfalls and Mistakes to Avoid
After seeing numerous exchanges, here are the mistakes that derail them:
Missing the 45-Day Deadline
This is the number one exchange killer. Life gets busy, you can’t find the right property, your broker is on vacation, and suddenly it’s Day 44 and you haven’t identified anything. The deadline is absolute, and missing it means paying the taxes in full.
Solution: Start your replacement property search before you sell. Have a short list of candidates before Day 0 so you’re not scrambling.
Touching the Money
If the sale proceeds hit your bank account — even briefly, even accidentally — the exchange may be disqualified. This seems simple, but it happens more often than you’d think, usually due to closing agent errors.
Solution: Make sure your QI, attorney, and closing agent are all coordinating. Triple-check the wiring instructions.
Insufficient Replacement Value
If you sell for $3M and buy for $2.8M, you have $200K of taxable “boot.” Some exchangers don’t realize they need to replace the full value, including debt.
Solution: Work with your CPA to calculate the exact numbers before you identify replacement properties. Know your minimum acquisition target.
Using a Related Party as QI
Your attorney, CPA, real estate agent, or family member cannot serve as your QI (if they’ve acted as your agent within the past 2 years). Use an independent, professional QI.
Forgetting About the Tax Return Deadline
The 180-day period can be shortened if your tax return is due (including extensions) before Day 180. This usually only affects sales that close in October, November, or December. If you sell in November and don’t file an extension, your 180 days gets cut to whenever your April 15 return is due.
Solution: Always file an extension to preserve the full 180-day window.
Advanced Strategies: Reverse Exchanges and Build-to-Suit
Reverse 1031 Exchange
What if you find the perfect replacement property before you’ve sold your facility? A reverse exchange allows you to acquire the replacement property first and sell the relinquished property afterward.
It works through an “Exchange Accommodation Titleholder” (EAT) — an entity that takes title to the replacement property and “parks” it until you sell your existing property and complete the exchange. You still have 45 days to identify and 180 days to complete.
Reverse exchanges are more complex and expensive (expect QI/EAT fees of $10,000–$25,000+), but they solve the timing problem. If the right property comes along at the right price, a reverse exchange ensures you don’t miss the opportunity.
Build-to-Suit (Improvement) Exchange
You can also use 1031 exchange proceeds to build improvements on replacement property. For example, you could buy land and use exchange funds to construct a new self storage facility on it, as long as the construction is substantially complete within the 180-day window.
This requires careful structuring (the QI or EAT holds title during construction), but it gives you the flexibility to create exactly the replacement property you want.
Delaware Statutory Trusts: The Passive Replacement Option
For self storage owners who want to exit active real estate management entirely, Delaware Statutory Trusts (DSTs) are worth understanding.
A DST is a legal entity that owns institutional-quality real estate — typically large apartment communities, distribution centers, medical office buildings, or other stabilized properties. As an investor, you purchase a fractional interest in the DST, which qualifies as like-kind replacement property for a 1031 exchange.
Benefits of DSTs as replacement property:
- Completely passive. No management, no tenants, no maintenance calls.
- Institutional-quality real estate. DSTs typically own institutional-grade properties with strong tenants and professional management.
- Flexible investment amounts. You can split your exchange across multiple DSTs to diversify.
- Monthly income. Most DSTs distribute monthly cash flow to investors.
- Solves the 45-day identification problem. DST interests can often be identified and closed quickly, which helps when the clock is ticking.
Risks and limitations:
- Illiquid. You can’t easily sell your DST interest. Typical hold periods are 5–10 years.
- No control. You’re a passive investor; you don’t control the property or the management decisions.
- Fees. DST sponsors charge upfront fees (typically 10–15% of invested capital) that reduce your effective investment.
- Sponsor risk. The quality of the DST depends entirely on the sponsor’s competence and integrity. Due diligence on the sponsor is critical.
DSTs aren’t right for everyone, but for self storage owners who are done with active management and want to preserve their wealth on a tax-deferred basis, they’re a valuable tool in the toolkit.
Working With a Qualified Intermediary: What to Look For
Your QI is the linchpin of the entire exchange. Here’s what to evaluate:
Experience and track record. How long have they been facilitating exchanges? How many have they handled? Ask for references.
Financial safeguards. Your exchange funds should be held in segregated, FDIC-insured accounts (or invested in government securities). Ask about their fidelity bond and errors and omissions (E&O) insurance coverage.
Responsiveness. Exchange timelines are tight. You need a QI who answers calls, responds to emails promptly, and won’t drop the ball on Day 44.
Cost. QI fees are relatively modest ($750–$1,500 for a standard forward exchange). Don’t choose a QI based on price — choose based on competence and security.
Independence. The QI should be independent and have no conflicts of interest. They should not have served as your agent, broker, accountant, or attorney within the past two years.
A Note on Tax Reform Risk
We’d be remiss if we didn’t mention this: Section 1031 has been a target of various tax reform proposals over the years. While it has survived every attempt to eliminate or curtail it (thanks in large part to aggressive lobbying by the real estate industry), there’s always a risk that future legislation could modify or restrict 1031 exchanges.
This is not a reason to panic — 1031 exchanges have existed since 1921 and have bipartisan support as an engine for real estate investment. But it is a factor to consider in your timing. If you’re going to do an exchange, doing it under the current rules eliminates the risk that future changes could limit your options.
The Bottom Line
A 1031 exchange is one of the most powerful tax deferral tools available to self storage owners. By reinvesting your sale proceeds into qualifying replacement property, you can defer hundreds of thousands of dollars in taxes and keep your capital working for you.
But it requires careful planning, strict adherence to timelines, and the right professional team. Don’t try to figure this out on your own.
Important disclaimer: This article is educational information about 1031 exchanges, not tax or legal advice. Tax law is complex and your specific situation is unique. Before executing a 1031 exchange, consult with a qualified CPA and tax attorney who can advise you based on your individual circumstances.
Planning an Exit From Self Storage?
We work with 1031 exchange specialists to ensure a smooth transition. Whether you’re exchanging into another self storage facility, diversifying into a different asset class, or exploring passive options like DSTs, we can connect you with the right professionals and coordinate the entire process.
Start the conversation early — the best exchanges are planned months in advance, not scrambled together at the last minute.
[Let’s Plan Your Exit Strategy →]