Tax Strategy

Exit Strategies: Harvesting Real Estate Wealth Tax-Efficiently

Maximize After-Tax Proceeds

Learn tax-efficient real estate exit strategies including 1031 exchanges, installment sales, CRTs, and stepped-up basis planning to minimize taxes when selling.

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45 Days

1031 Identification Deadline

180 Days

1031 Closing Deadline

25%

Depreciation Recapture Rate

Tax at Death with Stepped-Up Basis

Quick Answer

1031 exchange defers all capital gains and depreciation recapture indefinitely when reinvesting in real estate
Installment sales spread gain recognition over time, keeping you in lower tax brackets
Stepped-up basis at death eliminates all deferred gains and recapture - sometimes the best exit is no exit
Charitable Remainder Trusts convert appreciated property to diversified income stream tax-free
Depreciation recapture (25% rate) is often overlooked - factor it into all exit calculations

The Options

Exit Strategy Comparison

1031 Exchange: Defer Indefinitely

Sell property, reinvest in like-kind real estate, defer ALL capital gains and depreciation recapture. No limit on how many times you can exchange. Continue deferring until death when heirs receive stepped-up basis - making deferrals permanent tax elimination. The most powerful exit strategy in real estate.

Installment Sale: Spread the Tax

Sell property with seller financing. Capital gains are recognized proportionally as payments are received over time. Spread large gains across multiple tax years to stay in lower brackets. Also provides steady income stream and interest income. Works well for older investors seeking income.

Charitable Remainder Trust: Income + Deduction

Transfer appreciated property to CRT, receive income stream for life, and get immediate charitable deduction. CRT sells property tax-free internally and invests proceeds. At death, remainder goes to charity. Converts concentrated real estate into diversified income without immediate capital gains.

Stepped-Up Basis at Death: Ultimate Exit

Hold property until death and heirs receive stepped-up basis to current market value. ALL capital gains and depreciation recapture disappear. For a $500K property now worth $2M with $300K depreciation taken, $1.5M gain + $300K recapture ($75K at 25%) vanishes. Sometimes the best exit is no exit.

Implementation

Proven Strategies

1031 Exchange into Management-Free Assets

Exchange from active management properties into passive investments: Delaware Statutory Trusts (DSTs), NNN lease properties, or management-free syndications. Maintain 1031 deferral while eliminating landlord responsibilities. Ideal for retiring investors who want to keep tax deferral without management headaches.

Best for: Investors seeking to exit active management while preserving tax deferral and maintaining income.

Example:

Own 10-unit apartment building worth $2M, basis $800K, $400K depreciation taken. Potential tax: $300K+. Exchange into DST portfolio of NNN retail properties. $0 immediate tax. Receive 5-6% cash yield with zero management. At death, heirs inherit at stepped-up basis.

Installment Sale with Self-Directed Exit

Sell property to buyer with seller financing over 10-30 years. Spread capital gains across tax years. Structure for income needs while minimizing annual tax burden. You become the bank, earning interest while deferring principal gains recognition. Works exceptionally well for retirement income planning.

Best for: Investors who need steady income and want to minimize peak tax years during retirement.

Example:

$1M property with $400K gain. Outright sale: $100K capital gains tax. Instead, seller finance over 15 years at 6% interest. Annual principal recognition ~$67K, gain recognition ~$27K. Tax ~$6K/year vs $100K upfront. Plus $60K/year interest income.

Charitable Remainder Trust for Appreciated Property

Transfer highly appreciated property to CRT. CRT sells property tax-free and invests proceeds. You receive income stream (5-50% of trust annually) for life or term of years. Immediate charitable deduction for present value of remainder. At death/term end, charity receives remainder.

Best for: Charitably inclined investors with highly appreciated property seeking income diversification.

Example:

$2M property, $200K basis. Direct sale: $360K federal tax. Instead, donate to CRT. CRT sells tax-free, invests $2M. 6% payout = $120K/year income. Charitable deduction ~$600K (saves $220K in taxes). Net: more income, $220K immediate tax savings, $0 capital gains.

Avoid These Pitfalls

Common Mistakes

Missing 1031 Exchange Deadlines

The 45-day identification window and 180-day closing deadline are absolute. Miss either and the entire exchange fails - you owe full capital gains tax. Start identifying replacement properties BEFORE you close on the sale. Work with a qualified intermediary from day one.

Selling When Stepped-Up Basis is Near

If you are elderly or in poor health, selling may trigger massive unnecessary tax. At death, heirs receive stepped-up basis, eliminating all gains and depreciation recapture. Consider refinancing to access equity tax-free instead of selling. Consult estate planning before any late-life sale.

Ignoring Depreciation Recapture

Many investors focus only on capital gains and forget depreciation recapture is taxed at 25% (Section 1250) regardless of capital gains rates. On a property with $300K depreciation, that is $75K in recapture tax alone. Factor this into all exit strategy calculations.

Questions

Common Questions

Here are the most common questions we receive about this topic.

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Long-term capital gains (held >1 year) are taxed at 0%, 15%, or 20% depending on income. Add 3.8% Net Investment Income Tax for high earners. Depreciation recapture is taxed at 25% flat rate. State taxes add 0-13%+. For high-income investors in high-tax states, combined rates can exceed 35%.

Yes. You can exchange part of the proceeds into replacement property and take cash (boot) on the remainder. You pay tax only on the boot received. Many investors exchange 90-95% and take some cash for liquidity while still deferring most tax.

All deferred gains and depreciation recapture are eliminated through stepped-up basis. If you have been exchanging for 30 years and deferred $2M in gains, your heirs inherit at current market value with zero built-in gain. This is why many investors never stop exchanging.

Different purposes. 1031 maintains real estate exposure and defers indefinitely. Installment sale exits real estate but spreads tax over time. Installment sale is better if you want to leave real estate entirely. 1031 is better for continued real estate investment with tax deferral.

Partially. You must live in the property 2 of the last 5 years to qualify for $250K/$500K exclusion. However, gain attributable to depreciation and non-qualified use (rental periods after 2008) is not excludable. This strategy works but rarely eliminates all tax on former rentals.

Ready to Plan Your Real Estate Exit?

The right exit strategy can save hundreds of thousands in taxes. Let us help you evaluate all options and create a tax-efficient transition plan.

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