1031 Exchanges
A 1031 exchange—named after Section 1031 of the Internal Revenue Code—allows real estate owners to defer capital gains taxes when selling an investment property, as long as the proceeds are reinvested into a “like-kind” property of equal or greater value. This deferral can significantly increase long-term wealth by keeping more equity at work in the market rather than paying it immediately to the IRS.
The IRS requires strict compliance with two timelines: 45 days to formally identify potential replacement properties and 180 days to close on the new acquisition. Missing these deadlines—even by a single day—can disqualify the exchange and trigger an immediate tax bill. Because of this, advance planning, coordination with qualified intermediaries, and careful selection of replacement assets are critical.
This strategy works especially well for owners who wish to remain invested in real estate but want to diversify their portfolio—for example, exchanging a single multifamily building for multiple smaller assets in different geographic markets, or swapping an actively managed property for one that requires less hands-on involvement.
DST Investments
A Delaware Statutory Trust (DST) offers a solution for investors who want to maintain the tax benefits of a 1031 exchange but transition into a more passive role. DSTs provide fractional ownership in large, institutional-grade properties such as Class-A multifamily communities, medical office buildings, industrial warehouses, or even portfolios of self-storage facilities.
Professional asset managers handle leasing, maintenance, and financing decisions, meaning investors can enjoy passive income streams without the day-to-day headaches of property management. For retirees or those seeking to step back from active ownership, DSTs can be an attractive option.
However, DST investments are illiquid—once you commit, it’s typically a long-term hold (5–10 years). Investors should carefully review the sponsor’s track record, fee structure, and debt obligations before committing. Due diligence is critical to ensure that the projected income distributions are realistic and that the underlying assets fit your long-term objectives.
Installment Sales
An installment sale allows a property owner to sell and receive the purchase price over time rather than in a lump sum. By spreading the payments across multiple tax years, the seller effectively spreads out recognition of the capital gain. This not only smooths taxable income but can also keep the seller in a lower tax bracket in any given year.
For example, if a $2 million gain is reported all in one year, the seller might face the top federal capital gains rate plus state taxes. But if structured as an installment sale with payments over ten years, each year’s tax liability may be far more manageable.
The key is structuring the note properly to protect the seller. This includes negotiating a competitive interest rate, securing the note with collateral or guarantees, and making sure legal agreements clearly define remedies in case of buyer default. It can be an elegant solution for buyers who need flexibility while still providing sellers with predictable cash flow and tax efficiency.
Combining Strategies
In practice, many sophisticated owners design hybrid exit plans that combine elements of each strategy. For instance:
- Partial Cash Out – Take a portion of the sale proceeds immediately for liquidity.
- DST Allocation – Invest part of the proceeds into a DST to preserve 1031 benefits while offloading management responsibilities.
- Installment Note – Finance part of the transaction for ongoing income and deferred taxation.
Such layered approaches allow owners to balance immediate financial needs with long-term wealth preservation. They also provide flexibility in meeting different family, retirement, or estate planning goals.
Coordinating these strategies requires early engagement with CPAs, legal counsel, and qualified intermediaries, since the rules are strict and missteps can be costly. The best results come from building a customized plan that aligns not only with tax efficiency but also with lifestyle, liquidity needs, and legacy objectives.
In summary, 1031 exchanges, DST investments, and installment sales each offer powerful tools for deferring taxes and shaping an exit strategy. But the most successful outcomes typically come from careful planning, professional guidance, and strategic blending of these approaches into a plan that matches the owner’s long-term vision.
