If you own investment property, tax deferral strategies could be a viable method of maximizing wealth and optimizing financial planning depending on your investment goals and tax situation. Understanding tax deferral could help you determine approaches to dealing with income and appreciation in connection with your real estate portfolio.
The Tax-Deferral Definition
A tax-deferred approach delays tax payments on income or capital gains to a future date. When dealing with real estate, common tax deferral approaches include:
- The 1031 Exchange. Section 1031 of the Internal Revenue Code can help you defer capital gains taxes and depreciation recapture if you sell an investment or business property and invest the proceeds into a like-kind property of equal or greater value.
- Delaware Statutory Trusts (DSTs). When used with a 1031 exchange, DSTs allow fractional real estate ownership with tax-deferred benefits while removing active management responsibilities.
- Qualified Opportunity Zones (QOZs). You could defer and potentially reduce capital gains taxes by reinvesting profit from asset sales into government-designated Opportunity Zones. The program promotes economic development in lower-income areas.
The Pros and Cons of Tax Deferral
On the surface, tax deferrals can offer many benefits, including the following:
More capital to reinvest. A tax deferral strategy can let you keep the money that might otherwise go to taxes. You could use those funds to acquire new assets or diversify your portfolio, potentially boosting long-term wealth accumulation.
Tax rate optimization. With careful planning, the tax deferral approach could help you time tax payments for when you’re in a lower income tax bracket. This might reduce what you owe to the IRS.
Estate planning advantages. If you’re planning to pass DST shares or other real estate to your heirs, a tax deferral approach could help preserve their wealth. For example, assets acquired through a 1031 exchange might be eligible for a step-up in basis when passed on, potentially eliminating capital gains taxes for the heirs.
However, there are drawbacks to tax deferral strategies:
You could owe more. Tax deferral doesn’t get rid of taxes. The process puts off what you owe until you sell a property or a DST dissolves. Depending on the property appreciation amount and your tax bracket, you might pay more taxes through a deferral strategy rather than paying them upfront.
Deferral strategies are complex. A successful 1031 exchange means compliance with stringent IRS rules. The process also involves extra costs, including Qualified Intermediary fees. There are also specific rules for Opportunity Zone investments.
Yes or No? Deciding to Use a Tax-Deferral Approach
Tax deferral strategies can help with financial growth, capital reinvestment, and long-term wealth preservation. However, you could end up owing more money. Additionally, relying on 1031 exchanges, DSTs, and QOZ to defer taxes requires strict compliance with rules and regulations.
A tax deferral strategy decision requires thought and advice from your CPA, real estate broker, or attorney. If you decide to proceed, consider contacting the professionals at Realized 1031 for assistance with 1031 exchanges, DSTs, and other approaches. For more information, visit realized1031.com.
The tax and estate planning information offered by the advisor is general in nature. It is provided for informational purposes only and should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.
