Swap Till You Drop vs Installment Sale: 1031, Borrow and Hold
"Swap till you drop" means you never sell for cash: you 1031 exchange when you want a different building, borrow against it when you need money, and hold until death so your heirs get a stepped-up basis. For an older owner with heirs, a strong building and modest borrowing, it often beats an installment sale on what the heirs receive. The installment sale wins when you want out of the building, need income that does not depend on a loan, would have to borrow heavily at today's rates, or could be forced to sell in a bad decade.
This comparison is one chapter of The Waterfall Strategy, titled "Have Your Cake and Eat It Too." This page gives the logic and simple examples; the book has the full model runs.
The idea in three moves
Swap. When you want a different property, do a 1031 exchange. The gain rolls into the new building. No tax today.
Borrow. When you need money, take a loan against the building. Loan proceeds are not income.
Hold. At death, your heirs take a basis equal to the value on the date of death (§1014(a)). The deferred gain and the depreciation recapture are never taxed. In a community property state like California, both halves of community property step up at the first spouse's death (§1014(b)(6)). See step-up in basis on rental property for how title, heirs' depreciation and suspended losses play in.
It is legal, and people also call it "buy, borrow, die." The question is not whether it works. It is whether it works for you.
Why the step-up does the heavy lifting
Most people think the borrowing is the clever part. It is not. Holding until death is.
Simple example. A building worth $3,000,000 with an adjusted basis of $700,000, after $300,000 of depreciation. Federal tax only, using the ceiling rates (25% on building depreciation, 20% on the rest of the long-term gain, 3.8% net investment income tax on all of it), no state tax, no selling costs.
| Simple example | Sold during life | Held until death |
|---|---|---|
| Gain | $2,300,000 | $0 (basis steps up to $3,000,000) |
| 25% layer ($300,000) | $75,000 | $0 |
| 20% layer ($2,000,000) | $400,000 | $0 |
| 3.8% NIIT ($2,300,000) | $87,400 | $0 |
| Federal tax at the ceilings | $562,400 | $0 |
A state like California would add more to the left column and nothing to the right one.
An installment note cannot do that. The unpaid gain on a note is income in respect of a decedent: no step-up, and your heirs pay tax as the payments arrive (§§691(a)(4), 1014(c)). See what happens to an installment note when the seller dies.
One more cost of holding if you have stuck passive losses: at death, suspended losses are allowed only to the extent they exceed the step-up (§469(g)(2)). On a building with a big gain, the loss bank can die with you. A taxable sale is what releases them (see suspended passive losses when selling a rental).
The catch: interest you cannot deduct
When you borrow against a rental and spend the money on your life, the interest is generally not deductible. Interest follows the use of the money, not the property that secures the loan (Reg. §1.163-8T). Spend it on living costs, travel or a grandchild's tuition and it is personal interest, which is not deductible (§163(h)).
Two exceptions:
- Interest on debt used to buy or improve the rental stays deductible against the rent.
- If you park loan money in an investment account, that interest is investment interest, deductible only up to your net investment income (§163(d)).
Simple example: the cost of a $1,000,000 loan spent on living.
| Loan rate | Yearly interest | Pre-tax income needed to pay it at a 35% combined rate |
|---|---|---|
| 5.0% | $50,000 | about $76,900 |
| 6.5% | $65,000 | $100,000 |
| 8.0% | $80,000 | about $123,100 |
Every year the loan is outstanding, that interest comes out of after-tax money. The installment sale works the other way: the note pays interest to you.
Today's rates vs 2021
The pitch for swap till you drop was written when money was cheap. The Freddie Mac 30-year fixed rate averaged 2.96% in 2021 and was 7.03% on September 24, 2026 (Freddie Mac Primary Mortgage Market Survey, via the St. Louis Fed's FRED series MORTGAGE30US). Those are owner-occupied home loans. Loans on rentals and commercial property usually cost more, and depend on the building, the lender and you.
That is why the book ran the comparison at several loan rates instead of one. Get a real quote before you decide anything.
Borrowing around a 1031: timing matters
Borrowing is tax-free. Borrowing as part of the exchange may not be.
- Right before the exchange. In Long v. Commissioner, 77 T.C. 1045 (1981), a $400,000 note signed two days before an exchange of partnership interests was disregarded as "too close" to the exchange, and the excess debt relief was taxed as boot. In Garcia v. Commissioner, 80 T.C. 491 (1983), a new loan the replacement's seller put on the property at the buyers' request was respected because it had independent economic substance.
- At closing. Cash you take out is boot. New debt on the replacement offsets debt relief on the old building, but it never offsets cash you receive (Reg. §1.1031(d)-2, Example 2).
- After the exchange. A loan on the replacement once the exchange is closed is the cleaner path. No rule sets a safe waiting period. Make the refinance its own deal, with its own purpose and paperwork.
For how boot is measured and taxed, see 1031 boot.
Side by side: what the book's model runs found
The book ran a composite California couple in their 60s through four plans, each funding the same yearly spending: keep and borrow, keep without borrowing, a structured installment sale, and a cash sale. It also ran a "bigger 1031 and borrow" plan against taking the same money out as structured boot. The full tables, assumptions and stress tests are in the book. The pattern:
| Situation | What tended to win in the model runs |
|---|---|
| Older owner, heirs, strong building, spending close to the rent | Keep and borrow |
| A cheap loan already in place that you do not refinance away | Keep and borrow, strongly |
| Spending far above the rent, so the loan keeps growing | The sale; the loan hits the lender's limits |
| High loan rates on a large balance | The sale |
| A bad decade: values fall or go flat when you need to refinance | The sale; the building is forced onto the market with no step-up |
| You might sell before death anyway | Structured boot over a bigger building and a loan |
| You want the most money to spend while alive, not the biggest estate | The note |
The short version from the book: the note funds a bigger life; the loan funds bigger heirs. And the break point is not a gentle slope. When the loan reaches the lender's limit in a downturn, the plan can fall off a cliff into a forced sale, which is the worst result of all: no step-up, the whole deferred gain and recapture taxed, and the loan paid off from what is left.
Where swap till you drop breaks
- Age and health. The plan pays off at death. The longer the wait, the more interest you pay.
- Heavy spending. The more you spend above what the rent pays, the bigger the loan, and the more the rate matters.
- The lender. Lenders test value and rent coverage at every refinance. A building that is fine can still fail the test.
- Management fatigue. You stay a landlord until you die: roofs, tenants, rent rules, insurance, and one building's risk in your 80s.
- Heirs. Heirs who inherit a building with a big loan also inherit the refinance risk. With no heirs, or charity as the heir, the step-up is worth little to you.
- The law. Treasury's budget proposals for fiscal years 2023 through 2025 would have treated death as a sale, with a $5 million per-person exclusion. They were proposals, not law. If something like them passed, the case for holding would shrink, and a note would lose nothing it has today.
Who should hold and borrow; who the note is for
Hold and borrow may fit if you are older, healthy enough to hold, have heirs you want to leave the building to, own a strong building, spend close to what it pays, have a cheap loan already in place, and can carry debt into your 80s.
An installment sale may fit if you want out of management, debt and one building's risk; you want a fixed schedule that does not depend on rents or values; rates are high relative to your rent; you have no heirs; or you have stuck passive losses that a taxable sale would set free, which is the core idea of The Waterfall Strategy.
The note can be seller financing, where the buyer owes you, or a structured installment sale, where the buyer pays in full and an assignment company, usually funded by a fixed annuity it owns (some programs use a funding agreement), owes you on a schedule set before closing. In a structured sale you are an unsecured creditor of the assignment company, the schedule cannot be sped up or pledged, the commission is built into the pricing, and no IRS ruling specifically approves the structure; it relies on the general installment rules. See the installment sale guide and alternatives to selling a rental property.
Bottom line
Swap till you drop is real, and for the right older owner it is often the best tax plan there is. The step-up does the heavy lifting; the loan is the risk. An installment sale wins when you want out, want income that does not depend on a building or a lender, would borrow heavily at today's rates, or could be forced to sell in a bad decade. Get a real loan quote and run both plans with your CPA. The full model runs are in the book: get The Waterfall Strategy.
Questions to ask your CPA
- If I hold until death, how much deferred gain and recapture does the step-up erase, and is my property community property or joint tenancy?
- If I borrow, how much of the interest is deductible under the tracing rules, and how much is personal interest?
- What happens to my suspended passive losses if I hold until death versus sell now?
- How long should I wait after an exchange before refinancing, and how should the refinance be documented?
- What loan rate and spending level would make an installment sale the better plan for me?
- If one of us dies first, how do the survivor's brackets change the comparison?
Get the full playbook. The Waterfall Strategy, the 20-minute version and the one-page Cliff Notes, free.
Educational only, not tax, legal or investment advice. Examples are illustrative. Have your CPA or tax attorney review your facts before you act. Hans Goldstein is a licensed insurance agent (CA Insurance License #4273294) and is not a CPA or attorney. He is paid a commission only if a structured installment sale is funded; seller financing pays him nothing. Disclosures.