Picture this: You’re standing in front of your latest real estate investment, a charming vacation rental that’s tripled in value since you bought it. You’re ready to sell and reap the rewards of your savvy investment.
But wait! Before you pop the champagne, there’s a party crasher you need to deal with: capital gains tax.
Don’t worry, though. We’ve got some strategies to help you keep more of your hard-earned profits. Welcome to the world of real estate tax deferral strategies.
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The real estate market: A seller’s paradise
If you’re a real estate investor in 2025, you’re probably feeling pretty good right now. The market is favoring sellers, with limited inventory driving up prices. Interest rates have stabilized and might even be on their way down later this year. It’s a great time to cash in on your investments, but no one wants to hand over a big chunk of their profits to the taxman.
That’s where tax deferral strategies come in. These aren’t magic tricks to make your taxes disappear, but they are legitimate ways to postpone or potentially decrease your capital gains tax. The goal? To keep more money in your pocket and work for you.
Working to reduce your capital gains tax is a delicate dance and one that must be undertaken quite carefully. As always, it’s good advice to work with an experienced and knowledgeable team that knows every move and how to make them. With that in mind, let’s explore five savvy strategies that can help you keep as much of your hard-earned money.
Strategy No. 1: The low-income-year limbo
Imagine you’re playing limbo with the IRS. The lower you go (in income), the better you do. That’s the basic idea behind our first strategy: selling assets during a low-income year.
Here’s how it works:
Meet Jack, a successful real estate investor. He owns several properties, including a small apartment building he bought for $500,000 five years ago. It’s now worth $800,000, which means he’s looking at a $300,000 capital gain if/when he sells.
Typically, Jack’s income puts him in the highest tax bracket. But this year, he’s taking a sabbatical to travel the world (lucky guy!). His income will be much lower than usual.
By selling his apartment building this year, Jack can take advantage of lower tax rates on his capital gains. Instead of paying 20% (the highest long-term capital gains rate), he might pay only 15% or even 0% if his income is low enough.
The key here is to understand your capital gains tax rate is determined by your overall taxable income. So, if you can time your property sale to coincide with a year when your income is lower, you could save a bundle. Be sure to work your tax professional into the conversation for some personalized, up-to-the-minute advice if you’re timing a transaction like this.
Strategy No. 2: The installment sale shuffle
If the idea of a big lump sum (and the accompanying tax bill) makes you nervous, you might want to try the installment sale shuffle.
An installment sale proceeds something like this:
Sarah owns a commercial property worth $1 million. She bought it for $600,000 a few years ago, so she’s looking at a $400,000 capital gain. Instead of selling it outright, she agrees to an installment sale with the buyer.
The buyer pays Sarah $200,000 upfront and agrees to pay the remaining $800,000 over the next four years. This spreads Sarah’s capital gain over five tax years instead of hitting her all at once.
In year one, Sarah recognizes only 20% of her capital gain ($80,000), significantly reducing her tax burden for that year. Plus, she gets to defer taxes on the rest of the gain until she receives the payments.
But remember, there are rules to this dance:
- The first installment must be paid within one year after the tax year of the sale.
- You need to record the sale on IRS Form 6252.
It’s like eating your favorite dessert over a week instead of all at once — you still get to enjoy it, but without the sugar rush (or in this case, the tax hit).
Strategy No. 3: The charitable cha-cha with donor-advised funds
Who says you can’t do good and save on taxes at the same time? Enter the donor-advised fund (DAF), a charitable investment account that lets you support your favorite causes while potentially reducing your tax bill.
Let’s consider the case of Tom, who just sold a rental property for a $500,000 gain. Instead of facing a hefty tax bill, he decides to open a DAF and contribute $100,000 of his gains.
Tom gets an immediate tax deduction for his contribution, which helps offset the capital gains tax on his property sale. Plus, the money in the DAF can be invested and grow tax-free. Tom can then recommend grants from the fund to his favorite charities over time.
It’s like having your cake, eating it, too, and then sharing it with others — all while the IRS picks up part of the tab. Keep in mind there are adjusted gross income limitations with DAFs, and always run your plans by your tax advisers.
Strategy No. 4: The 1031 exchange two-step
Now, let’s talk about the granddaddy of all real estate tax deferral strategies: the 1031 exchange, also known as a “like-kind exchange.” 1031 exchanges have been around for about a hundred years, and when you soak in the advantages, it’s easy to see why:
Lisa owns a small office building that she bought for $1 million. It’s now worth $1.5 million. Instead of selling and paying taxes on the $500,000 gain, Lisa decides to do a 1031 exchange.
She sells her office building and uses all the proceeds to buy a larger commercial property worth $2 million. Because she’s essentially swapping one investment property for another, Lisa can defer paying taxes on her $500,000 gain.
But be careful. The 1031 exchange rules are strict:
- The new property must be “like-kind” (generally, any real estate held for investment qualifies) and generally cost at least as much as, or more than, the relinquished property.
- You must identify potential replacement properties within 45 days of selling your original property and close on the new property within 180 days. (See a timeline for 1031 exchanges.)
- The money — the proceeds from the sale of the original property — must be held by a qualified intermediary (QI), who is also responsible for transmitting it to the entity selling the new property. The QI facilitates the transaction in many other ways, as well.
The 1031 exchange can be a powerful tool, especially for building a real estate empire. You can potentially defer taxes indefinitely by continually rolling your gains into new properties. And if you hold on to these investments until you pass away, your heirs might even receive a “step-up in basis,” potentially eliminating the capital gains tax liability altogether.
Strategy No. 5: The opportunity zone tango
Our final strategy involves investing in qualified opportunity zones (QOZs) — economically distressed communities identified by the government as needing investment. Unlike 1031 exchanges, QOZs have a fairly recent operating history, having their origins in the Tax Cuts and Jobs Act (TCJA) of 2017.
Let’s look at Mark, who just sold a property and has $1 million in capital gains. Instead of paying taxes on this gain, he invests the full amount into a qualified opportunity fund (QOF) that’s developing properties in a QOZ.
By doing this, Mark can defer paying taxes on his $1 million gain until December 31, 2026 (or until he sells his QOF investment, whichever comes first). That’s a great benefit. But the real magic comes if he holds his QOF investment for at least 10 years … because he’ll pay zero capital gains tax on any appreciation of his QOF investment after that.
It’s like the government is giving you a tax break for helping revitalize communities. Talk about a win-win.
The grand finale: Putting it all together
Now that we’ve explored these strategies, you might be wondering, “Which one is right for me?” The answer, as with most things in finance, is: It depends.
Your specific situation, goals and risk tolerance will all play a role in determining the best strategy (or combination of strategies) for you. That’s why it’s crucial to work with a team of professionals who understand both real estate and taxes.
Think of it like assembling your own tax-deferral dream team:
- A savvy real estate broker to help you identify great investment opportunities
- A knowledgeable CPA to navigate the complex tax landscape
- A skilled financial adviser to ensure your real estate strategy aligns with your overall financial goals
- And in the case of 1031 exchanges, a qualified intermediary who can quarterback your transaction from beginning to end
Together, this team can help you choreograph a tax-deferral strategy that keeps you dancing all the way to the bank.
The curtain call: Final thoughts
Remember, the goal of these strategies isn’t just to defer taxes indefinitely. Tax deferral is a means to an end: It’s really about keeping more of your money working for you, potentially increasing your returns over time and aligning your real estate investments with your broader financial objectives.
Tax laws and regulations are always changing, so what works today might not work tomorrow. Stay informed, stay flexible, and don’t be afraid to adjust your strategy as needed.
So, the next time you’re facing a big capital gains tax bill on your real estate investment, don’t panic. Take a deep breath, put on your dancing shoes and remember: With the right moves, you can keep more of your profits while the taxman waits in the wings.
