Selling an appreciated property can create a great problem to have—but it can also create a large tax bill.
If you’ve owned real estate for years, the property’s value may have increased significantly while your tax basis has decreased through depreciation. Before you sell, it’s worth asking: Do you have a strategy for the tax that comes with the sale?
Depending on your circumstances, strategies such as a Section 1031 exchange, Delaware Statutory Trust (DST), or UPREIT may help you defer taxable gain while repositioning your real estate portfolio.
Here’s what real estate investors should know.
1031 Exchange: Keep Your Investment Working
A Section 1031 exchange allows an investor to potentially defer recognition of gain when exchanging qualifying real property held for investment or business purposes for other qualifying real property.
In simple terms, instead of selling one investment property, paying tax on the gain, and then investing what remains, a properly structured 1031 exchange can allow you to reinvest the proceeds into another qualifying property and defer the gain.
Key 1031 Exchange Rules
Keep these requirements in mind:
- Investment or business property: The properties generally must be held for investment or business purposes. Property held primarily for sale, such as real estate inventory, generally does not qualify.
- 45-day identification period: You generally have 45 days after transferring the old property to identify potential replacement property.
- 180-day exchange period: You generally must acquire the replacement property within 180 days, subject to applicable tax-return timing rules.
- Qualified intermediary: A qualified intermediary (QI) generally facilitates the exchange and helps prevent you from taking actual or constructive receipt of the sale proceeds.
- Cash and other property: Receiving cash, certain debt relief, or other non-like-kind property—often referred to as “boot”—may result in taxable gain.
Important: A 1031 exchange generally defers tax; it does not permanently eliminate it. The deferred gain typically carries into the replacement property.
DSTs: A More Passive Approach to 1031 Investing
What if you want to continue investing in real estate but don’t want to manage another property yourself?
A Delaware Statutory Trust (DST) may be an option worth considering.
Certain DST interests can qualify as replacement property in a 1031 exchange under Revenue Ruling 2004-86, provided the applicable requirements are met.
Instead of purchasing an entire property yourself, a DST can allow investors to own a fractional interest in a professionally managed real estate investment.
Why Consider a DST?
Potential advantages include:
- 1031 compatibility: Certain DST interests may qualify as replacement property in a 1031 exchange.
- Passive ownership: Professional management can reduce the day-to-day responsibilities of directly owning rental property.
- Diversification: Depending on the offering, investors may gain exposure to larger commercial or institutional-quality properties.
- Potential access to different asset types: DST offerings may provide exposure to property types that could be difficult for an individual investor to purchase directly.
However, DSTs are not risk-free. Investors should carefully evaluate:
- Investment fees and expenses
- Limited liquidity
- Financing and debt structure
- Property-specific risks
- Offering terms
- Potential returns and distributions
Tax treatment is only one part of the decision.
UPREIT & Section 721: Another Path for Real Estate Owners
Some property owners want to move away from direct property ownership but still maintain an investment in real estate.
An UPREIT (Umbrella Partnership Real Estate Investment Trust) may provide another potential strategy.
In a typical UPREIT structure, an investor may contribute qualifying real estate to an operating partnership associated with a REIT in exchange for operating partnership (OP) units.
Under Section 721, qualifying property contributions to a partnership generally do not trigger immediate recognition of gain, provided the applicable requirements are satisfied.
What Should Investors Consider?
- Potential tax deferral: A qualifying Section 721 contribution can generally defer recognition of gain.
- REIT exposure: OP units can provide economic exposure to a broader real estate platform.
- Liquidity: OP units may provide more flexibility than directly owning a property, although converting or selling them can create taxable consequences.
- Estate planning: Depending on the circumstances, inherited assets may receive a basis adjustment under applicable tax rules, which can affect the treatment of deferred gain.
Because UPREIT transactions can be complex, investors should evaluate the tax, investment, liquidity, and estate-planning consequences before contributing property.
1031 vs. DST vs. UPREIT: Which Strategy Fits?
There is no single strategy that works for every investor.
The right approach depends on your property, financial position, investment objectives, and long-term plans.
Consider factors such as:
- Current property value
- Adjusted tax basis
- Potential capital gain
- Depreciation-related gain
- Outstanding debt
- Liquidity needs
- Investment timeline
- Risk tolerance
- Diversification goals
- Estate and succession planning
At a Glance
| Strategy | May Be Suitable For | Key Consideration |
| 1031 Exchange | Investors who want to continue owning qualifying real estate | Requires careful timing and compliance |
| DST | Investors seeking a more passive real estate structure | Limited liquidity and offering-specific risks |
| UPREIT / Section 721 | Owners considering a broader REIT-based investment structure | More complex structure and tax considerations |
The goal isn’t simply to defer tax. The goal is to choose a strategy that supports your broader financial and investment objectives.
Plan Before You Sell
One of the biggest mistakes real estate investors can make is waiting until after the sale to think about taxes.
Once a property has been sold and the proceeds have been received, many planning opportunities may no longer be available.
Before selling, review:
- Your tax basis
- Expected gain
- Depreciation history
- Existing debt
- Potential tax liability
- Reinvestment options
- Liquidity needs
- Long-term investment and estate-planning goals
Early planning gives you more options and more time to structure the transaction properly.
Ready to Evaluate Your Options?
At SAI CPA Services, we help real estate investors evaluate the tax consequences of property transactions and identify potential planning opportunities before a transaction takes place.
Whether you’re considering a 1031 exchange, DST, UPREIT, or another real estate strategy, the best time to start planning is before you sell.
Thinking about selling an appreciated property? Contact SAI CPA Services before the transaction closes to review your potential tax exposure and explore the strategies that may fit your goals.
