There used to be only a few ways for real estate investors to make money. You could buy a property and rent it out, you could buy, improve it, and then re-sell, or you could buy and hold, then sell at a later time without making any updates. And often these methods triggered massive tax obligations that ate into the investors’ wealth. Nowadays there are more options than ever before for real estate investing and many of them offer the benefit of tax deferment. Let’s explore some of the best tax deferral options out there for real estate investors.
721 Exchange
What if you could transfer the ownership of a property you own into a partnership and receive distributions for your contribution? This is the basic premise of a 721 exchange. Investors move their property into an UPREIT structure or a real estate partnership. They get operating partnership units that can then be converted into shares or can be sold.
The transfer of the property is not a taxable event. This offers investors the opportunity to move real estate out of their portfolio, earn passive income, and lower their overall tax burden. There are many great 721 exchange companies that offer this service to savvy investors. It allows for further portfolio diversification and is excellent for investors who want more passive income opportunities.
1031 Exchange
Similar to a 721 exchange in that you can move ownership of a property and defer taxes, 1031 exchanges are another great option for investors. In this option, investors sell their property to a new owner and then use the proceeds to reinvest in a similar property within 45 days of the sale. They continue to manage the new property and are a great option if the investor wants to take a more active role in managing their real estate.
Installment Sales
When investors want to spread out their tax obligations over many years, an installment sale is an excellent option. Instead of receiving the money for the sale all at once, triggering a massive capital gains tax bill, investors can split up the receipt of payments over multiple years. This means that each year they will pay a small portion of capital gains taxes and this can help them hang onto more of their wealth from year to year. There are reporting rules that must be followed along with limits on when the funds must be received after the date of the sale.
Qualified Opportunity Zones
Real estate investors know that diversification is important, so buying in qualified opportunity zones is a helpful way to do that. A QOZ is a lower income area that often has many properties waiting to be purchased and turned into rental and other income generating opportunities. Each time an investor sells a property, it becomes a taxable event. By reinvesting funds into a QOZ within 180 days of the sale, you can defer tax payments. There are certain regulations you need to follow, and the longer you hold the property, the more tax deferral options you will have.
Primary Residence Capital Gains Exclusions
Many people fear that they could owe capital gains taxes when they go to sell their homes. The good news for investors is that as long as they meet certain requirements, they could sell their primary residence without triggering any capital gains taxes at all. For a single homeowner, the first $250,000 of profit is excluded from capital gains taxes, and for a homeowner who is married filing jointly, that amount is $500,000. For real estate investors who want to hold onto more of their wealth, this exclusion is one of the best strategies out there.
Delaware Statutory Trust
Did you know that a Delaware Statutory Trust can serve as a replacement property in a 1031 exchange? This is good news for investors who want to continue gaining the benefits of real estate, but without the direct management and tax obligations. Instead of directly owning a property, funding goes into a trust and then all members of the trust direct funds into different real estate investing options. Not only does this allow for diversification, it means that selling a property won’t necessarily trigger capital gains responsibilities. In this model a trustee directly manages the properties while each of the investors gets a beneficial interest in the trust. Meaning that funds earned through rents and sales get distributed to each trustee.
