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A little clarity for your next decision.
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Investor WorkspaceA little clarity for your next decision.
By Jerry Baker
An Arizona 1031 exchange can defer eligible federal gain when investment real estate is exchanged under the required rules. Before you buy, check water service, local demand, cooling costs, and the ground beneath the buildings. This guide explains how I review those issues for a direct purchase or a Delaware statutory trust, called a DST.
A state can attract attention without every property in it being a good investment. A busy construction site does not tell me whether an apartment building can raise rents. A new employer announcement does not tell me how many workers will live near the property. And a familiar city name does not tell me what happens when a loan comes due.
I start with a more useful question: what needs to happen for this particular investment to work? Who are the tenants, and what rent can they afford? What will it cost to keep the building in good shape? What might a future buyer pay?
For an Arizona purchase, I want separate answers about the water provider, cooling equipment, drainage, and ground conditions. These are different risks. A steady water supply does not prove that the land has stable soils. A newer building does not prove that its cooling budget is realistic. Each claim needs its own evidence.
This guide gives you a way to review a property. It does not claim a current vacancy rate or promise a return. It also does not mean I have an Arizona investment to offer today. A decision needs current records for the actual property and an understanding of your exchange.
Section 1031 generally applies to real property held for investment or business use. It does not turn a personal vacation purchase into an exchange property. The replacement need not have the same use as the property sold, as long as both qualify. The tax result still depends on the transaction and how both properties are held. [1]
For a standard delayed exchange, arrange the qualified intermediary before the sale closes. You generally have 45 calendar days after the transfer to identify the replacement property. Completion generally must occur within 180 calendar days or the due date of the relevant federal return, including extensions, if earlier. You must follow the written identification rules. A casual list of addresses is not enough. [2]
I would put those dates beside a second schedule: financing, inspections, title review, water documentation, and closing. A property can look appealing and still need more work than time allows. An inspection that raises a question is useful only if there is time to answer it.
Ask your tax adviser to calculate the equity and debt requirements, expected closing adjustments, and any taxable cash or debt relief. Do not use the gross sale price alone as a final exchange budget. Ask about each state involved, too. Buying Arizona property does not, by itself, settle the tax treatment of a sale in another state.
My goal is to compare workable choices before the deadline starts driving the decision. A shorter list of fully reviewed properties is more useful than a long list with unanswered questions.
Arizona ended the local tax described in A.R.S. 42-6004(H) on the business of renting real property for residential purposes after December 31, 2024. The statute contains exceptions, including health care, long-term care, and hotel, motel, or other transient lodging businesses. This is a specific tax change, not an exemption from every tax connected with owning Arizona real estate. [3]
That distinction matters when reviewing an older income statement. Suppose a seller provides records from before and after the change. I would ask the property accountant to explain how the old charge was collected, reported, and removed. Was it a tenant payment passed through to the taxing authority? Was it included in a rent total? Did the budget adjust both sides of the transaction?
Removing a pass-through charge is not automatically the same as increasing the owner's income. If the revenue and expense both disappear, the net result may differ from the sales presentation. Review the actual lease language and the accounting treatment rather than adding the old tax amount to future profit.
For mixed-use property, separate the residential space from commercial or lodging activity. For a property with prior tax balances, ask for an explanation and documentation. The tax change should not become an excuse to skip the property's history.
Finally, keep property taxes, income taxes, and taxes on business activity in different budget lines. They have different rules and different payers. Your CPA should confirm the relevant treatment; a broker's phrase such as “tax friendly” is not a tax analysis.
Arizona's Department of Water Resources, or ADWR, runs two related programs. Assured Water Supply applies within Active Management Areas. Adequate Water Supply applies outside them, with different approval and disclosure rules. Both evaluate a 100-year supply. Certain jurisdictions outside the management areas require a showing of adequacy before final subdivision approval. [4]
There are also designated water providers. Under ADWR's guidance, a written service commitment from a designated provider can meet the relevant supply requirement without a separate developer determination. The details matter: the provider, service area, property, and proposed use must line up. A provider's name on a map is not the complete file. [4]
These programs should not be reduced to “every Arizona property has a 100-year guarantee.” They address specific supply and building requirements. I would ask for the records. Then I would have a qualified adviser explain what they cover.
A leased building may have years of service records. Vacant land may still need permits, pipes, and other work. The review should make that difference clear. Both may involve water, but they are not the same investment problem. Existing service records also do not automatically establish approval for an expansion.
ADWR's Phoenix groundwater page describes limits on new Assured Water Supply determinations based on groundwater, while distinguishing developments supported by existing certificates or designations. The page includes updated modeling material for 2026. Separately, ADWR reported implementation of its Alternative Designation of Assured Water Supply program in 2025. These sources show why it is wrong to assume that no new projects can proceed in the Phoenix area. [5] [6]
I would not jump to the opposite claim, either: that a new pathway removes water risk from every site. Ask which pathway applies to the property. Is the approval in hand? Is it pending, or just possible? What conditions remain? Who has confirmed that the plan uses the current rules?
Suppose a seller prices land as though hundreds of homes can be built there. A nearby subdivision's approval would not be enough for me. I would want the proposal's own water file, infrastructure budget, land-use approvals, and realistic schedule. If the return depends on approvals that do not exist, the investor should see that dependency clearly.
For an existing rental property, I might focus on rates, leaks, and equipment. I would also check service history and plans for added use. I would still ask the sponsor how those facts were checked. “We have always bought in this market” is experience, not a substitute for current documentation.
Arizona's courts explain that landlords must maintain installed residential cooling systems and keep premises fit and habitable, subject to the governing laws and facts. Check local codes, too. I would not assume that a residential landlord can simply postpone a failed system until the next budget year. [7]
For an apartment purchase, ask for an equipment list: installation dates, recent repairs, warranties, service contracts, and replacement estimates. Compare that list with the funds set aside for repairs. Twenty systems nearing replacement are a different problem from one isolated repair, even if the current annual expense looks similar.
I also want to know who pays the electric bill. The tenant may pay the utility directly. The owner may pay it. Or the owner may bill the tenant for a share. Those methods can produce very different cash flows. Read the leases and test the collection history. A budget that assumes full reimbursement should show how that assumption works in practice.
Here is a simple illustration. A hypothetical property has $250,000 of annual cash flow before a newly identified cooling replacement reserve. Setting aside $25,000 reduces that amount to $225,000. On $3 million of investor equity, the difference is about 0.83 percentage point a year. This is arithmetic, not an estimate of Arizona equipment costs or a tax deduction.
The answer is not always to reject the property. The purchase price, reserves, warranties, and repair plan may address the issue. But the replacement cost should appear somewhere. It should not vanish because the first-year distribution looks better without it.
The Arizona Geological Survey describes earth fissures as ground fractures associated with land subsidence. Subsidence is downward movement of the surface, including movement related to removal of groundwater. Fissures can affect foundations, roads, pipes, and drainage; heavy monsoon rain can enlarge them. AZGS publishes mapping resources and points owners toward qualified technical review. [8]
This does not mean that every Arizona parcel has a fissure. It means that a smooth parking lot does not tell you what lies below it. A map, survey, inspection, or past repair may raise a concern. Ask a qualified expert to study it. Then decide what it means for the purchase.
AZGS also provides a hazards viewer with layers for fissures, faults and earthquakes, flood potential, and fire risk. Use it to organize questions. A map cannot price a repair or explain an insurance policy. A blank area on the map does not prove there is no risk. [9]
For drainage, I would ask how water moves across the property during a storm. Who maintains channels, basins, and culverts? Are there shared agreements with neighboring owners? Does the site depend on drainage work that is still unfinished? Past repairs and claims can reveal issues that marketing photos miss.
Ask the insurance adviser for the written terms. What is covered, and what is excluded? What limits and deductibles apply? Do not treat a lender's acceptance of a policy as proof that every loss is covered. The useful question is how the owner would pay for a loss that falls outside coverage.
Arizona's Office of Economic Opportunity offers employment, wage, labor-force, and projection data at several geographic levels. The catalog separates actual job counts from forecasts. It also lets you compare local areas. These are useful starting points, not property-level rent forecasts. [10]
For an apartment building, I would connect the proposed rent to likely tenant income, commuting patterns, competing units, and actual leasing results. Ask about concessions as well as advertised rents. A free month can make a headline rent look stronger than the amount collected over the lease.
For industrial property, the questions change. What does the tenant do in the building? How difficult would it be to replace that tenant? Does the user need special power, cooling, water, or loading areas? Is truck access an issue? A custom building may serve its present occupant well while costing more to adapt for the next one.
For retail, I would review tenant sales where available, occupancy costs, lease expirations, and the nearby competition. For land, I would check permits and the cost of roads and utilities. What will it cost to hold? Who might buy it later? A nearby project is useful context only after the connection to this property's cash flow is explained.
Ask for the date and geographic scope of every market chart. Do not compare a county unemployment measure with a metro-level job forecast as if they describe the same thing. I would rather see a modest forecast supported by relevant evidence than an impressive statewide chart with no clear link to the asset.
A properly structured DST may qualify as replacement real estate for a 1031 exchange under the conditions described in IRS Revenue Ruling 2004-86. The name “DST” alone does not establish that every trust or transaction qualifies. Review the offering documents and tax treatment with your advisers. [11]
With a direct purchase, you generally take on the work of arranging management, repairs, financing, and a future sale. A manager can handle daily tasks, but you still need to understand the agreement and supervise the business. That may suit an investor who wants control and is prepared for the work.
With a DST offering, ask who makes each decision and what powers the documents give that person. I would review the manager's response to a major repair, tenant loss, insurance increase, or loan issue. Passive ownership changes who does the work; it does not remove the property's expenses or risks.
Private offerings can involve limited liquidity, fees, conflicts, and a risk of losing principal. They do not come with a reliable on-demand resale market simply because the underlying real estate is familiar. You may be allowed to invest and still find that the deal does not fit your needs. [12]
An Arizona property could play one role within a broader portfolio. I would still test whether several investments share the same hidden exposure, such as one water provider, tenant, employer base, manager, or loan maturity. Owning more names is not necessarily the same as reducing concentration.
Before making a decision, I would want a short written summary that connects the evidence to your needs. What do we know? What remains unclear? Which assumptions matter most to the result?
I would also assign an owner and a due date to each open question. “Waiting on water documents” is too vague. Which document, who is obtaining it, and when must it be reviewed? That simple discipline helps keep the exchange schedule from hiding unfinished work.
The objective is not to prove that Arizona is good or bad. It is to understand whether a specific investment has a sound plan, whether the risks are clear, and whether those risks make sense for you.
It may, if it is held for investment or business use and the exchange meets the required rules. Location alone does not establish eligibility. Review ownership, use, timing, identification, and the handling of sale proceeds before closing. [1] [2]
No. The change effective in 2025 addresses a specified local tax on residential rental activity and has stated exceptions. It does not make property ownership or all related income tax-free. Have the property's accountant separate the applicable taxes and explain historical charges. [3]
No. A water determination addresses specified supply requirements. It does not guarantee rent, property value, service costs, or investment returns. Confirm which documents and provider apply to the parcel and whether the business plan changes the property's water needs. [4]
A map is a starting point for investigation, not an investment verdict. Ask qualified specialists to assess the location, condition, repair options, and consequences. Then review the budget and insurance terms in light of their findings. [8] [9]
Ask for equipment ages, service history, replacement estimates, reserve assumptions, and the responsibility for utility bills. Have the manager explain how legal obligations and local requirements are handled when a system fails. The cost and operating plan should be visible before you invest. [7]
Not automatically. Compare the real estate, manager, debt, fees, reserves, and decision rights. A DST can reduce your daily management role while leaving you exposed to investment losses and limits on selling your interest. The structure and your needs both matter. [11] [12]
Educational information, not an offer or a personal tax, legal, or investment recommendation. Examples are hypothetical and omit stated adjustments. Tax treatment depends on your facts and current law. Review your transaction with your CPA, attorney, and qualified intermediary. Real estate investments can lose value and may be illiquid.
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