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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
Texas real estate can serve as replacement property in a qualifying 1031 exchange, whether you buy a building directly or invest through a properly structured DST. The state's lack of an individual income tax does not remove federal tax rules, local property taxes, or investment risk. This guide focuses on the Texas costs, records, and property questions I would review before committing exchange funds.
When someone tells me they want to invest in Texas, my next question is: what do you want that investment to do? Current income, less management work, growth, and control over a future sale can lead to different choices.
A state name cannot tell us whether the rent is sound, the loan is manageable, or the purchase price leaves room for mistakes. I would want to see the specific property, tenant base, expenses, and business plan. The attractive part of a large market is choice. The hard part is sorting those choices.
Texas also is not one uniform rental market. A warehouse near an airport, a suburban apartment complex, rural land, and a building leased to an energy business need different research. Even two properties in one city can compete for different customers. Start with the users of the space, then work outward.
Texas does not impose an individual state income tax. That fact can matter in a comparison, but it is not a complete after-tax forecast. Federal taxes remain, and the investor's residence or other states' source-income rules may matter. The Comptroller's current tax material should be the starting point for Texas claims. [1]
Ask your CPA to make a map of the ownership and cash flow. Where do you live? Which entity owns the property? Where did the deferred gain originate? What happens when the property sells? Those facts are more useful than a “tax-free state” tag.
California offers a clear example of why this matters. Its Form 3840 instructions track California-source gain when California real estate is exchanged for out-of-state property. Buying in Texas does not, by itself, erase that history. [2]
Texas franchise-tax rules also need separate review. The Comptroller says its definition of a passive entity differs from federal tax concepts, and rental income is not passive income for that specific test. Do not conclude that an investment escapes entity-level rules merely because the investor takes a passive role. Have counsel review the actual structure. [3]
Texas has no state property tax, but local governments levy property taxes. Counties, school districts, cities, and special districts can all affect the bill. The Comptroller's January 2026 guide explains the local appraisal and tax system. A purchase analysis should use the actual parcel and its taxing units. [4]
Ask for the last several bills, appraised values, exemptions, and any pending disputes. Then ask which figures the sponsor used for future years. A past reduction or settlement does not promise the same result next year.
For a property receiving special treatment, find out why it qualifies and what could change that treatment. Do not copy a seller's favorable tax figure into your forecast without review. The tax adviser should explain any change-of-use exposure and the records supporting the budget.
I would show taxes as a separate line in the model. For a hypothetical apartment property, a $40,000 expense increase reduces annual cash available by $40,000 before any offset. A plan should not hide that impact inside a general assumption that rents will grow.
With a net-leased property, ask who pays the bill under the lease and what happens if the tenant does not pay. A tenant obligation can reduce the owner's routine work. It does not make the building immune to unpaid expenses or a vacancy.
The IRS generally permits like-kind treatment for qualifying real property held for investment or use in a business. Property held mainly for sale does not qualify. A move from one U.S. state to another is not, by itself, a problem; foreign real estate is a different matter. [5]
In a common delayed exchange, set up the qualified intermediary before the sale closes. The 45-day written identification period and the exchange period run together. The latter ends at the earlier of 180 days or the return due date, including extensions. Access to the sale money must remain restricted under the arrangement. [6]
I would put the exchange calendar beside the investment review calendar. How long does the lender need? Is the title review complete? Are there documents that require correction? When will funds be accepted? Those practical dates should come before the legal last day.
A local storm, bank holiday, or unavailable signer can create a closing problem even when the property is sound. Do not assume a deadline automatically moves. Ask the QI and tax adviser whether any specific relief applies and document their answer.
Population or employment growth is not the same thing as rent growth at a particular address. New space may arrive faster than demand. Existing buildings may offer concessions to compete. The question is how much demand reaches the property after customers weigh price, location, and alternatives.
The Texas Workforce Commission offers data on jobs, wages, unemployment, and industries at different geographic levels. Use those tools to examine the relevant region, and keep the report dates visible. A state total does not prove that the tenants near your property are doing well. [7]
For housing supply, the Census Building Permits Survey is one useful source of authorized construction data. A permit is not proof that a building has opened or leased. Pair the data with a current local project list and a clear distinction between proposed, permitted, under-construction, and completed units. [8]
Ask the sponsor to identify the actual competitors. What do their customers pay after free-rent offers and other incentives? Are the units or buildings truly comparable? What advantages does the subject property have that can be verified?
A forecast with rising rents and steady occupancy can be reasonable, but it needs support. I would also run a case with flat effective rents and a slower lease-up. That shows whether the plan requires everything to work at once.
The Texas Department of Insurance notes that commercial property policies are not standardized. Policies can cover different causes of loss and use different terms. A sponsor saying “the property is insured” is the beginning of the review, not the answer. [9]
Ask for the insured values, deductibles, exclusions, limits, and renewal date. Review wind, hail, flood, and business-income terms with the insurance adviser. Confirm which coverages are included and which require a separate policy.
A large percentage deductible can be meaningful even when the premium looks manageable. Have the adviser translate it into dollars for the specific buildings and explain how it applies. Then compare that potential cash need with available reserves.
Also review the roof's age, past claims, repair records, and recommendations from inspections. Deferred maintenance and storm damage can become difficult to separate after a loss. Good records help both the operating team and the review process.
Do not model an insurance recovery as immediate cash. Ask how repairs would be funded while a claim is reviewed and what happens if tenants cannot use the building. The loan still needs attention while the property is recovering.
The Texas Water Development Board provides mapping tools for flood conditions and groundwater data. Those tools help identify questions, but they do not replace an engineer's site work or the controlling floodplain records. Review the parcel, roads, utilities, and surrounding drainage together. [10]
A building may sit above a mapped flood area while its only practical access route is exposed. A loading yard can be unusable even when offices remain dry. Ask the engineer to explain how the property would function under the hazards relevant to that site.
For land and properties dependent on wells, identify the water source, permits, delivery rights, and expected demand. Texas groundwater conservation districts have management plans, and the Water Development Board provides district information. Do not assume that owning the land answers every water-use question. [11]
For a development-dependent plan, I would want written utility commitments, capacity details, and the expected cost of connections. “Utilities nearby” is not the same thing as service available on the schedule and terms in the model.
For apartments, begin with the rent roll, collections, concessions, and the cost to turn units. Check how many leases expire in the same season. Ask whether the renovation plan has been tested in comparable units and whether the forecast reflects downtime.
For industrial property, review truck circulation, dock access, clear height, power, fire protection, and possible replacement tenants. A long lease can be useful, but a highly specialized building may require substantial work if the tenant leaves.
For retail, distinguish the store's brand from the legal entity on the lease. Review any guaranty and the remaining lease term. Ask which repair obligations stay with the landlord. A well-known sign does not write the rent check; a specific tenant does.
For land, identify the source of return. If there is little current income, taxes, insurance, upkeep, and financing may consume capital while the owner waits. The exit depends on a future buyer who wants the land at an acceptable price.
These are review questions, not a list of property types that are automatically suitable. The same investor may reasonably accept one risk and reject another based on the rest of their finances.
A DST interest can provide exposure to real estate while leaving daily management to the parties named in the documents. That can appeal to an owner who no longer wants tenant calls or repair decisions. It also means accepting limits on control.
Revenue Ruling 2004-86 describes a DST structure whose interests qualified for the stated federal tax treatment. The ruling depends on its facts and restrictions. Review the offering's tax analysis; the name “DST” alone does not establish that it fits your exchange. [12]
Ask who can change the operating plan, make major repairs, handle a tenant problem, and decide when to sell. Find out what happens if the structure must change under financial stress. Convenience is useful only when you understand what you are giving up.
Private placements can be illiquid and may offer less disclosure than public securities. You can lose your investment. The SEC's investor guidance emphasizes reviewing the documents and being prepared for a long holding period. [13]
A forecasted exit in seven years is not a redemption promise. If you need money for a known expense in three years, address that need before treating a long-term real estate interest as available cash.
Debt can help meet an exchange target, but it also changes investment risk. Review how much debt is allocated to your interest, when the loan matures, whether the rate can change, and what reserves the lender requires.
Consider a hypothetical $400,000 equity investment with 40% investor-level LTV. Ignoring other adjustments, it represents about $666,667 of property value and $266,667 of debt. The calculation divides equity by one minus LTV. Actual offering and closing figures must control the exchange reporting.
A 5% cash distribution on that $400,000 would equal $20,000 a year if paid for a full year. That rate does not tell you what the property will sell for. It also does not tell you whether the cash came from operations, reserves, or another source.
I would ask for the bridge from property revenue to investor cash: operating expenses, debt service, reserves, fees, and distributions. If a projection skips a step, ask where it went. A return chart should not make costs disappear.
Here is a hypothetical example, not a Texas market forecast. A property has $900,000 of revenue and $400,000 of operating expenses. That leaves $500,000 of net operating income before debt service and other investor-level costs.
Now assume revenue falls by $45,000 while taxes, insurance, and repairs rise by $55,000. Net operating income falls to $400,000, a 20% decline. If annual debt service is $300,000, the remaining amount falls from $200,000 to $100,000 before reserves and fees.
The example shows why modest-looking changes can have a larger effect on equity cash flow. It is not a prediction of loss, and it leaves out many real-world details. I would ask the sponsor to run the same exercise using the actual property's expenses and debt.
Then test the exit. What if a buyer demands a higher return and pays less for the same income? Could loan payoff, sale costs, and other charges leave less equity than expected? Income and sale assumptions belong in the same discussion.
| Area | Documents or answers |
|---|---|
| Income | Leases, collections, tenant details, concessions, and current operating results |
| Local costs | Tax records, forward tax assumptions, insurance terms, and repair budget |
| Physical condition | Engineering, roof, drainage, environmental, and utility reviews |
| Financing | Loan terms, maturity, reserves, covenants, and investor debt allocation |
| Ownership | Offering or purchase documents, control rights, fees, and exit provisions |
| Exchange | QI agreement, identification, closing calendar, and CPA's calculation |
I would also keep a short list of open questions. Give each question an owner and a date for a response. A thick document folder is not the same as a completed review. The point is to understand the few facts that could change your decision.
Potentially. Qualifying U.S. investment or business real estate can be like-kind across state lines. Your transaction must still meet the federal rules, and your advisers should check the state where the original gain arose. [5]
No. Texas has no individual income tax, but your residence, prior gain, ownership entity, and other states' rules can affect the result. Local property taxes and possible entity-level obligations also belong in the review. [1] [3] [4]
They should be addressed in the operating model, but you must verify the assumptions. Ask whether the projection uses a past bill, a current assessment, or an estimate of future costs. Also check who pays under the lease.
No. Review drainage and flood exposure at the actual site and along access routes. Texas offers statewide water and flood mapping resources. Maps are a starting point for professional site review, not a guarantee against damage. [10]
It may spread some risks, but names alone do not show that. Compare locations, tenants, sponsors, lenders, property types, and loan maturities. Several interests can still depend on the same economic drivers or be exposed to the same event.
Before the sale closes when possible. That allows time to define your needs, select the QI, gather records, and review choices without a rushed decision. Once the transfer occurs, the exchange deadlines leave less room for problems. [6]
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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