Whether you own residential or commercial property(s), selling your real estate can be a complex process, especially when it comes to tax implications and deferral options. The good news is the current real estate market favors sellers over buyers.
With limited inventory and sustained buyer demand, real estate investors looking to sell off some of their properties while simultaneously lowering their tax bill can benefit from certain tax-deferral strategies and investment options. By deferring capital gains taxes, sellers can potentially reduce their tax burden and reinvest in new opportunities.
Since each deferral option can affect your overall investment portfolio differently, it’s important to understand them before implementing. In this article, we will discuss how the capital gains tax works for real estate and three popular deferral options for sellers:
- 1031 Exchanges
- Delaware Statutory Trusts
- Opportunity Zone Investments
What Are Capital Gains Taxes?
The capital gains tax is the rate you pay on an asset’s increase in value over the time you owned it. The amount owed in taxes will vary based on how long you have owned the property, your filing status and your taxable income. Capital gains taxes can be applicable to any asset held for investment purposes: real estate, mutual funds, fine art, vehicles and stocks.
Types of Capital Gains Taxes
It’s also important to note that there are two types of capital gains taxes, short-term and long-term. If the asset has been owned for less than a year, then any gain would be subject to the short-term capital gains tax. The gain generated by the sale would be treated as ordinary income and be taxed at the less favorable ordinary income tax rates. On the other hand, if the asset is owned for at least a year and a day, any gain would be subject to the long-term capital gains tax, which is broken into three brackets:
Long-term Capital Gains Tax Rates by Year
|
Long-Term Capital Gains Tax Rates |
Tax Year 2026 |
|
0% |
Up to $49,450 for single filing Up to $98,900 for married filing jointly |
|
15% |
$49,451 – $545,500 for single filing $98,901 – $613,700 for married filing jointly |
|
20% |
Over $545,501 for single filing Over $613,701 for married filing jointly |
How To Defer Your Capital Gains Tax on Real Estate
As mentioned above, there are several tax strategies available to reduce or even defer your capital gains tax when selling residential or commercial property. Talk to your tax advisor to learn more about how each option could best work for your situation.
1. 1031 Exchange
A 1031 exchange, also known as a “like-kind exchange,” is named after Section 1031 of the Internal Revenue Code and allows investors to defer capital gains tax by exchanging real property held for business or investment purposes for similar real property that will also be held for business or investment purposes.
A unique benefit of a 1031 exchange is the ability to continue deferring the tax through future sales into additional 1031 exchanges. These types of transactions can be a powerful estate planning tool. If the right planning is done, the capital gains tax on the deferral will be eliminated due to the step up in basis to fair market value on the date of death. Therefore, no tax would be due on the original deferral.
It is important to note that the type of property that can be exchanged has been re-defined over time. The Tax Cuts and Jobs Act (TCJA) amended Section 1031 to limit its application to exchanges of real property and “incidental property” for exchanges completed after December 2, 2020.
Generally, taxpayers must identify the replacement property within 45 days of selling the relinquished property and then acquire the replacement property within 180 days of the sale transaction or by the due date of the tax return. Additionally, these transactions require the use of a qualified intermediary to facilitate the exchange.
Taxpayers who wish to take advantage of this tax deferral exchange provision will require advice as to the following:
- Whether or not to exchange
- Whether the properties to be relinquished and acquired meet the qualified use test
- Whether the property to be acquired is like kind with the property relinquished
- How much the taxpayer must spend on replacement property to achieve a fully deferred exchange
- The timing of the identification and reinvestment period
2. Delaware Statutory Trusts (DSTs)
Delaware Statutory Trusts (DSTs) offer another avenue for deferring gains on real estate sales. A DST is a real estate ownership structure where multiple investors each hold an undivided fractional interest in the holdings of the trust. DSTs are considered direct property ownership for tax purposes, thus making them eligible for 1031 exchange treatment — whether it is an interest being sold or as a replacement property. This allows investors to diversify their real estate holdings and gives them the opportunity to invest in institutional-grade properties typically out of reach for most individual investors.
Similar to the 1031 transaction discussed above, taxpayers who wish to take advantage of this tax deferral method will have strict time requirements for the reinvestment of the replacement property, the determination of taxability of any proceeds received, and recognition of their new role as a passive investor rather than a managing member.
3. Opportunity Zones
Opportunity zones (OZs), originally created by the TCJA (OZ 1.0), allow investors to defer capital gains by reinvesting eligible gains into a qualified opportunity fund (QOF) within 180 days of the sale or exchange. Under OZ 1.0, deferred gain must be recognized on the earlier of a disposition of the QOF interest or December 31, 2026. Investments made under OZ 1.0 were able to qualify for five- and seven‑year basis step‑ups (10% and 15% total) if certain timing requirements were met, and a 10‑year election to exclude post‑acquisition appreciation by stepping basis up to fair market value on disposition.
The 2025 "One Big Beautiful Bill Act" (OZ 2.0) makes the regime permanent and removes the fixed December 31, 2026 recognition date for new investments. For post‑2026 investments, deferred gain is recognized at the earlier of 1) a disposition of the QOF interest or 2) five years after the investment date, creating a rolling five‑year deferral, with a 10% basis step‑up after five years (30% for Qualified Rural Opportunity Funds) and continued access to a 10‑year election to exclude post‑acquisition appreciation; OZ 2.0 also adds an automatic basis step‑up at 30 years.
The reinvestment window remains 180 days, with special rules for passthroughs: if a partnership does not elect deferral, a partner can start its 180‑day period on (i) the date the partnership recognizes the gain, (ii) the last day of the partnership’s tax year (often December 31), or (iii) the partnership return due date without extension, effectively allowing investment as late as mid‑year of the following year.
Unlike 1031 or DST strategies where tax can potentially be eliminated via basis step‑up at death, OZ deferral (both 1.0 and 2.0) ultimately requires recognition of the original deferred gain under the applicable outside recognition rule, so cash‑flow planning for that eventual tax payment remains critical.
Capital Gains Deferral Frequently Asked Questions
Real estate investors can defer capital gains tax by reinvesting proceeds from a sale into certain qualifying investments or structures. Common strategies include completing a 1031 like-kind exchange, reinvesting through a DST or investing eligible gains into a QOF. Each option has specific timing, eligibility and risk considerations, so the best approach depends on an investor’s goals, liquidity needs and long-term strategy.
Short-term capital gains apply to assets held for one year or less and are taxed at ordinary income tax rates. Long-term capital gains apply to assets held for more than one year and are generally taxed at lower, preferential rates.
In some cases, investors may be able to combine or sequence deferral strategies, but doing so requires careful planning. For example, an investor might complete a 1031 exchange into a DST or later exit into a taxable transaction. However, deferral methods are governed by different rules, and not all strategies can be layered together. Working with a tax advisor is critical to avoid unintended gain recognition or compliance issues.
There is no single “best” strategy for deferring capital gains on commercial real estate. A 1031 exchange may be appropriate for investors seeking continued active ownership, while DSTs can appeal to those looking for passive income and diversification. OZ investments may be attractive for investors willing to accept longer holding periods in exchange for potential tax-free appreciation. The optimal approach depends on factors such as timing, cash flow needs, risk tolerance and estate planning objectives.
Yes. While OZ rules have evolved, the program remains an important deferral tool. Investments made under the original OZ framework are still subject to gain recognition in 2026, while newer investments benefit from a rolling five-year deferral period and continued access to long-term appreciation exclusion. Understanding which rules apply is essential when evaluating OZ strategies today.
Deferral strategies generally postpone when capital gains tax is due rather than eliminating it altogether. However, this is dependent upon what is rolled into the new investment and what, if any, cash is received or liabilities are relieved at sale. Some strategies, such as 1031 exchanges, may ultimately eliminate tax through a step-up in basis at death, while others such as OZ investments, require recognition of the original deferred gain at a specified point. Investors should plan for the eventual tax obligation as part of their broader cash flow and investment strategy.
Tax planning should begin before a property is sold. Many deferral strategies have strict timing requirements, and decisions made prior to closing can determine whether deferral is available at all. Engaging a tax advisor early allows investors to evaluate options, model outcomes and structure transactions in a way that aligns with their financial and investment goals.
Your Guide Forward
Considering the benefits and limitations that each deferral option offers, Cherry Bekaert’s Real Estate & Construction group can customize a strategic plan tailored to meet your real estate goals and objectives. By combining deep industry experience and technical knowledge of key tax, accounting, transaction structuring and compliance issues, we are uniquely positioned to provide the practical guidance and tools you need to make the right investment decision for your business.
Related Insights
- Article: Navigating the Complexities of Delaware Statutory Trusts
- Article: Qualified Opportunity Zone Fund vs. 1031 Exchange: Which One Is Right for Me?
- Article: Opportunity Zones Extended: How the 2025 Tax Reform Resets the Landscape for Community Investment
- Article: Tax Straddling and Installment Sales for a Failed 1031 Like-Kind Exchange
