There are several reasons why someone would want to look at tax deferral strategies for their commercial real estate holdings. It could be simply a desire to postpone the payment of capital gains taxes, or perhaps an investor wants to upgrade their holdings or diversify a portfolio. Estate planning is another popular reason for researching tax deferral options. Some have more altruistic goals and want to invest in distressed areas.
Regardless of the reason, there are different ways for real estate investors to manage their tax liabilities and optimize their investment portfolios. Here are three tax deferral strategies for commercial real estate and why you might want to choose them.
1031 Exchanges:
This investment strategy is named for Section 1031 of the IRS tax code. It allows investors to defer capital gains taxes when selling an investment property by reinvesting the proceeds from the sale of that property into another investment property. There are some exclusions in the type of property you can purchase, and all new property must be identified within 45 days of selling the old property. The final purchase transaction must be completed within 180 days. This strategy is beneficial for investors looking to upgrade or diversify their real estate holdings without triggering immediate tax liabilities.
Delaware Statutory Trust (DST):
A Delaware Statutory Trustor DST is an entity that holds the title to a real estate investment. Multiple investors can purchase an interest in the Trust, pooling their money to invest in larger properties or portfolios than they can alone. DST’s are commonly used in 1031 Exchanges. Instead of an investor directly purchasing a replacement property, they invest in a DST, which holds the title and management responsibilities for the property. In addition to the tax benefits of a 1031Exchange, DST investors can receive immediate income and potential appreciation of the real estate. This is a popular strategy for estate planning or someone who wants to transition from active to passive ownership.
Opportunity Zone Funds:
Opportunity Zones (OZ) are economically distressed areas designated by the U.S. government to encourage investment and economic development. The Opportunity Zone program provides tax incentives to investors who reinvest capital gains into Qualified Opportunity Funds (QOFs) that invest in properties within the designated OZ areas. This strategy allows investors to defer and potentially reduce capital gains taxes, and if they hold the investment for a certain period, they may qualify for additional tax benefits, such as a step-up in basis and tax-free gains on the appreciation of the new investment.