Seven ways to reduce your tax bill (legally)
If you live in a high-tax state like California or New York, your effective tax rate on a sale could be well above 35%.
Today, I want to build on this idea and share some options to defer your tax bill when a real estate investment is sold.
A few options are common. A few are more niche. And a few only make sense in very specific situations.
Here are the seven main options worth understanding.
1. Traditional 1031 Exchange
This is the one most real estate investors have heard of. In a 1031 exchange, you sell investment real estate and buy other like-kind investment real estate. If done correctly, you defer capital gains and depreciation recapture.
This can make sense if:
You directly own the property
You want to stay invested in real estate and don't want or need the proceeds
You are comfortable buying another property
You can meet the strict timing rules
You are okay dealing with a qualified intermediary
The big challenge is timing. You generally need to identify replacement property within 45 days of a sale and close within 180 days. That can create pressure.
Sometimes that pressure causes investors to buy a mediocre replacement property just to avoid the tax bill.
One option with a 1031 exchange is investing in a Delaware Statutory Trust (a "DST"), which is a passive option. DSTs typically involve high fees and low returns.
A traditional 1031 exchange does not work if you are selling a partnership interest or LP interest in a syndication or fund. The sponsor would have to decide to do a 1031 exchange.
2. “Lazy” 1031 Exchange
This is not a true 1031 exchange. A “Lazy 1031” is a nickname for a strategy some passive real estate investors use.
The basic idea is this:
You sell a property or receive proceeds from a real estate investment
You then redeploy those proceeds into a new passive real estate investment within the same calendar year
That new investment generates paper losses through a cost segregation study and bonus depreciation
Those passive losses offset passive gains and passive income, depending on your situation
For example, let’s say you sell a rental property and have a $100,000 gain. If you reinvest in a passive real estate deal in the same calendar year that generates a $100,000 paper loss from depreciation in year one, that loss may offset the gain.
You get the same end result as doing a traditional 1031 exchange.
This can make sense if:
You are a passive real estate investor invested in a fund or syndication
You have passive gains or passive income to offset
You want to keep investing in real estate
You work with a CPA who understands passive activity rules
This strategy can be powerful. But it is also very fact-specific.
3. Qualified Opportunity Zone Investment
A Qualified Opportunity Zone investment can allow you to defer certain capital gains by investing those gains into a Qualified Opportunity Zone investment.
This is not limited to gains from real estate.
It can potentially apply to capital gains from stocks, businesses, real estate, or other appreciated assets.
This can make sense if:
You have a large capital gain
You are willing to invest in a Qualified Opportunity Zone investment
You are comfortable with holding longer-term
You believe in the underlying project
You are not just chasing the tax benefit
The biggest potential benefit is not just deferring the original gain. If structured properly and held long enough, the future appreciation in the Opportunity Zone investment receives very favorable tax treatment.
The tax benefit should not be the reason you ignore the real estate, the market, the sponsor, or the business plan. A bad deal in an Opportunity Zone is still a bad deal.
4. Installment Sale
An installment sale is one of the simpler tax-deferral concepts. Instead of receiving all sale proceeds at closing, the seller agrees to be paid over time.
For example, the buyer might pay part of the purchase price up front and the rest through a note over several years. Because the seller receives payments over multiple years, the taxable gain may be recognized over those years as well.
This can make sense if:
You own the property directly
The buyer is willing to pay over time
You are comfortable receiving payments over time
You trust the buyer’s ability to perform
You want to spread taxable income across future years
The tradeoff is straightforward: you do not receive all your cash up front. You are also taking buyer credit risk.
And this is important: certain items, including depreciation recapture, may still need to be recognized in the year of sale. So an installment sale can be useful, but it is not a magic wand.
5. Deferred Sales Trust
A Deferred Sales Trust is more complex. It is related to installment-sale concepts, but it is not the same as a simple installment sale directly between a buyer and seller.
In a traditional installment sale, the buyer owes you payments over time. In a Deferred Sales Trust, a third-party trust is typically inserted into the transaction. The seller sells the appreciated asset through the trust structure, the trust receives or controls the sale proceeds, and the seller receives payments over time from the trust.
The easiest way to remember the difference: in an installment sale, the buyer pays you over time; in a Deferred Sales Trust, a third-party trust structure creates the payment stream over time.
The goal is similar: defer recognition of gain by spreading payments into future years. But the structure is very different.
This can make sense if:
You have a large gain
You do not want to buy replacement real estate
You want income over time
The buyer does not want to structure the purchase as an installment sale
You are comfortable with complexity
You are working with highly specialized legal and tax advisors
It involves more parties, more legal structuring, more fees, and more room for mistakes. It also requires the seller to understand exactly who controls the proceeds, how payments will be made, how the trust assets will be invested, and what risks exist if the strategy is challenged or poorly implemented.
I would not view this as a first option. I would view it as something to discuss only when the more common options do not fit.
6. 721 Exchange/UPREIT
A 721 exchange is another option that many investors do not know about.
At a high level, an owner contributes real estate to a partnership in exchange for partnership interests. If structured properly, that contribution may be tax-deferred.
This can be especially interesting when an owner is tired of actively managing a property but does not want to trigger a taxable sale.
We have seen situations where a property owner contributes their property into the fund that is purchasing the property. Instead of receiving all cash and paying tax immediately, the owner receives interests in the fund.
They go from actively owning and managing the property to becoming a passive investor in the property they used to own, while also gaining exposure to other properties in the fund.
This can make sense if:
You directly own appreciated real estate
You want to become more passive
You want diversification
You are comfortable owning partnership interests instead of the property directly
You understand the liquidity, valuation, and redemption terms
This can be a great fit in the right situation. But it is highly structure-dependent.
You need to understand what you are receiving, how and when you can get liquidity, what happens if the fund sells assets later, and whether the transaction creates any debt, disguised sale, or other tax issues.
7. Charitable Remainder Unitrust
A Charitable Remainder Unitrust, or CRUT, is a charitable planning strategy.
The basic idea is that appreciated property is contributed to a charitable trust. The trust may sell the asset, pay an income stream to the donor or other beneficiaries, and eventually distribute the remainder to charity.
This can make sense if:
You are charitably inclined
You have a highly appreciated asset
You want an income stream
You do not need all of the asset value to go to heirs
You are doing broader estate and tax planning
This is not just a tax strategy. It is a charitable strategy. If you are not charitably inclined, it probably does not make sense.
But for the right person, it can be a powerful way to combine tax planning, income planning, and generosity.
The Bigger Point
None of these options is automatically good or bad. They all depend on your situation.
Do you own the property directly or through a partnership?
Do you want liquidity or continued real estate exposure?
Do you want to stay active or become passive?
Do you have passive income or passive losses?
How soon is the sale?
The worst time to start asking these questions is after the sale has already closed.
The takeaway is simple: If you expect to exit a real estate investment soon, it is worth paying a very seasoned real estate CPA/tax strategist to walk through your options before the transaction happens.
After 11 years of working with high-net-worth investors, I can confidently say this:
Many CPAs are good at filing returns.
Fewer are proactive tax strategists.
That is not meant as a criticism.
It is just reality.
If you have meaningful real estate gains, you need to make sure your CPA is not just reporting what happened last year.
You need someone helping you think through what should happen next.
Best,
Ben Kahle
Managing Partner | Wellings Capital | www.wellingscapital.com
P.S. This email is for educational purposes only and is not tax advice. These strategies are complex, and your specific facts matter. Please consult your CPA, attorney, or tax advisor before taking action.
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