Keep Holding, Cash Out or 1031 Exchange

For more than a decade, commercial real estate was a remarkable investment. Then, in 2022, the Federal Reserve raised interest rates faster than at any time in forty years, and the market repriced. Owners now voice the same concerns:

“I’d love to sell my property, if only I knew what to do with the money.”

• Should I continue to hold, or is now the time to sell?
• If I decide to sell and just cash out, what kind of tax bill should I expect?
• If I sell and wish to defer the taxes, will that force me to buy back into the same market I just sold out of?
• How can I protect my principal? Are there alternatives that may do better during a recession?

The Bigger Picture

When I first wrote this piece in 2022, cap rates were at historic lows, many sectors were priced at 3–4% cap rates, and borrowing costs were starting to climb. I argued that prices had to break. They did. By the measure of Green Street’s Commercial Property Price Index, institutional-quality commercial property fell more than 20% from its 2022 peak, and office values fell by about a third.

As of September 2026, the market has partly recovered. Green Street’s all-property index is up about 5% over the past year, but it remains roughly 13% below the 2022 peak. The recovery is uneven. Mall and strip retail values are back at or above their peak, and industrial is within about 8%. Apartments were still nearly a fifth below peak at mid-year, and office remains about a third below. Much of the recent gain has come from rising rents rather than falling cap rates, and Treasury yields have moved higher again this year, which Green Street expects to cool pricing.

For an owner deciding whether to sell, three things follow.

• The tailwind is gone. For fifteen years, falling interest rates lifted values across the board. Today, returns have to come from the property itself: rent growth, occupancy and control of expenses.
• It depends on what you own. The owner of a well-leased strip center may be selling near a record price. The owner of a suburban office building may be looking at a loss against the 2022 appraisal. The same is true when you reinvest: a sector that has fully recovered is priced accordingly, and a sector still well below its peak raises the question of why.
• Borrowing costs matter again. The spread between property yields and mortgage rates is far thinner than it was during the low-rate decade, so leverage adds less to returns and more to risk. Any replacement property financed with short-term or floating-rate debt deserves particular scrutiny.

Cashing out – the math: Many investors would like to reduce or eliminate their exposure to real estate, for many reasons – to just cash out. After all, they sacrificed over the years to invest wisely and grow their wealth over a lifetime. And now that they have reached a stage in life where they can enjoy the fruits of their labor, they discover a rather cruel irony – they are going to get crushed in taxes.

• Federal tax: Long-term capital gains on real estate are taxed at up to 20%, and many sellers also owe the 3.8% net investment income tax on top of that.
• State tax: Most states tax capital gains at ordinary income rates, since they have no separate capital gains rate. State rates range from 0% to 13.3% (California).
• Recapture of depreciation: The portion of the gain attributable to depreciation deductions taken while you owned the property is taxed at up to 25%, before the 3.8% and state tax.
• Total: On a highly depreciated property in a high-tax state, the combined taxes can approach or exceed 40% of the gain – and when little basis remains, the gain is most of the sale price.
• The investor still has a reinvestment decision with the after-tax proceeds.

Every seller’s situation is different, and the figures above are general. Your CPA should run the numbers on your own sale.

Installment sale: Some investors mistakenly believe that an installment sale will address their tax and reinvestment problem. It does not. I have written a separate article on installment sales.

1031 Exchange, and defer the taxes: Most investors are understandably horrified when they discover the magnitude of their total tax bill. However, there is another option.

Real estate has a special feature in the tax code. An investor can sell their property and defer all the taxes (including depreciation recapture) if they reinvest the proceeds in like-kind property within certain time limits. (Like-kind means other real estate held for investment or business use.) An investor can hypothetically continue to buy and sell property, exchanging into the next purchase and deferring all tax liability, over a lifetime. At the end, when their heirs inherit the property, the cost basis is stepped up and the deferred tax liability is gone for good.

Given the tax consequences of cashing out, a 1031 exchange is a compelling alternative. However, it is not without its unintended consequences.

• The IRS exchange rules force an investor to buy back into real estate within a very short window of time. This may be inconsequential if the purchase is for a business purpose, or if the investor is diversifying the reinvestment across other markets or property types. It is very consequential if the investor is buying back into the same over-priced market they just sold out of.
• Owners who bought before the last decade’s run-up have usually done very well, even after the 2022 correction. Often they are so eager to avoid paying taxes that they rush into an exchange without the care and due diligence they exercised on the original purchase. In their haste to avoid paying 40 cents in taxes, they jeopardize their entire investment dollar in an ill-conceived exchange.

In 2006–2008, at the height of the last bubble, and again in 2021–2022, I noticed a troubling tendency among prospective clients, flush with capital gains and contemplating their next purchase.

• Some investors have done so well, so quickly, that they no longer have a genuine fear of risk. They believe real estate may experience a few bumps, that it may appreciate more slowly than in the past, but it will appreciate. The prospect of an actual loss of principal is unthinkable. On the contrary, they anticipate doubling their money yet again.

In the aftermath of the dot.com bubble, many of my friends and acquaintances, upon calculating their investment losses, lamented, “What was I thinking? Never again.” I heard the same refrain in 2009, after the real estate bubble. “It was so obvious. Never again.” In 2021, clients told me that 2009 could never happen again. “This time it’s different.”

Within two years, office values were down by a third.

• A second, more prevalent and more insidious tendency is reaching for yield. Reaching for yield is a classic investment pitfall, one that is taught in finance courses. It is a pitfall that professionals are just as likely to commit. Pension funds are often just as guilty as individual investors, and pension funds know better.

Many investors live off the net income produced by their real estate portfolio, and it is only natural to want more income. For more than a decade we lived in a low-yield world, and falling yields were a bonanza for property values. Yields are higher now, but the instinct has not changed: investors want to sell a low cap rate property and reinvest in a high cap rate one. What is often ignored in the equation is that high yield means high risk. And when the market pays little extra for taking risk, a higher yield often means much higher risk.

Too many investors look at yield first and foremost. They do not equate yield with relative safety or risk; they focus on the amount of income they need, or hope to get. They reach for yield without particular regard for the underlying dynamics of the market or of that particular property.

In a recession, the riskiest assets are those most vulnerable to fail – high yield bonds, start-up companies, and high yield real estate. Is it impossible to find low-hanging fruit, or a viable turnaround situation? No. Is it likely? If anything is trading at a significantly higher yield than the market, it is important to know exactly why. Especially after a long bull market, it is very easy to underestimate risk. And most people do not have nearly the risk appetite they think they have.

Originally written in 2022. Market commentary updated September 2026; property price figures are from Green Street’s Commercial Property Price Index.