Tax Deferral and Estate Planning Strategies

Owning an appreciated property is great, but eventually it raises a difficult question: what comes next?

Selling can trigger taxes on years of appreciation. Holding the property avoids a sale, but it also means continuing to own and manage the same asset. And if the property eventually passes to family, the next generation inherits more than its value. They may also inherit the decisions and responsibilities that come with owning it.

That is where tax deferral and estate planning strategies start to overlap. A 1031 exchange, Delaware Statutory Trust (DST), 721 UPREIT transaction, trust, or continued ownership can each play a role, depending on whether the goal is to stay invested, step away from management, change what the family owns, or plan how wealth eventually passes to beneficiaries.

This guide looks at those choices together so you can understand what each one solves and where it may fit in a longer-term plan.

Comparing Tax Deferral and Estate Planning Strategies

The tax deferral and estate planning strategies below address different parts of the planning process. A 1031 exchange, DST, or qualifying 721 UPREIT transaction can change what the investor owns next. A trust, on the other hand, addresses how those assets are owned and eventually transferred. Alternatively, the investor may choose to keep the existing property, preserving both the investment and the responsibilities that come with it.

Instead of picking a particular strategy, start with what you want to accomplish. If you want to remain a direct property owner, compare a 1031 exchange with continued ownership. If you want to stay invested in real estate but reduce management responsibilities, examine a DST or qualifying 721 UPREIT transaction. If the primary concern is who will control and eventually receive the assets, bring the trust structure into the discussion. In many cases, these decisions overlap, so the investment and estate-planning choices should be evaluated together before a transaction is completed.

The sections below examine each strategy in greater detail, including what it changes for the investor and what to consider before pursuing it.

1031 Exchanges

A Section 1031 exchange allows you to exchange qualifying business or investment real property for like-kind real property and defer recognition of eligible gain when the requirements are met. The basis of the relinquished property generally carries into the replacement property, subject to applicable adjustments.

For a deferred exchange, you usually have 45 days to identify replacement property and 180 days to complete the exchange, subject to applicable rules. You must also avoid taking actual or constructive receipt of the sale proceeds, which is why a qualified intermediary is typically involved.

A 1031 exchange allows you to continue a direct real estate ownership strategy. You select the replacement property, retain property-level control, and keep eligible proceeds invested in real estate rather than recognizing the deferred gain at the time of the exchange.

The important question is whether you still want what comes with direct ownership. Exchanging one property for another means you remain responsible for decisions involving financing, property management, capital improvements, and an eventual sale. If you expect to hold the replacement property as part of your estate plan, consider whether your beneficiaries are prepared to take on those responsibilities as well.

Before choosing a replacement property, evaluate it as both your next investment and a potential future estate asset. A property that satisfies the exchange requirements may not necessarily fit your long-term management, concentration, or succession goals.

DST

A DST can provide another replacement-property option for a qualifying 1031 exchange. Instead of exchanging into a property you own and manage directly, you purchase a beneficial interest in real estate held by the DST. The sponsor handles property-level management, while you remain invested in the underlying real estate.

Certain DST interests can qualify as replacement property under Section 1031 when the applicable requirements are met. This can allow you to defer eligible gain without taking on another property that requires your direct involvement.

The tradeoff is control. Because the sponsor makes the major property-level decisions, you generally cannot direct renovations, financing, leasing strategy, or the timing of a sale. DST interests are also typically illiquid, so you should review the anticipated hold period, financing, fees, distribution assumptions, property fundamentals, and sponsor before investing.

For estate planning, the change in ownership can also matter. If you later pass the DST interest to your beneficiaries, they may inherit a passive real estate interest rather than a property they have to operate. The DST itself is not an estate-planning vehicle, but it can change the type of real estate asset that eventually becomes part of your estate.

Before investing, evaluate the DST as more than a way to complete a 1031 exchange. The underlying property, sponsor, financing, fees, expected distributions, and exit strategy still determine whether it is an investment you would want to own even without the tax benefit.

721 UPREIT

A qualifying 721 UPREIT transaction can move you from direct ownership of real estate to an interest in a professionally managed real estate platform. Rather than selling the property for cash, you contribute qualifying real estate to a REIT's operating partnership in exchange for operating partnership, or OP, units.

Section 721 generally provides that gain or loss is not recognized when property is contributed to a partnership in exchange for a partnership interest, although exceptions apply. This can allow you to change the form of your real estate ownership without immediately recognizing eligible gain.

The shift can address more than management. If the operating partnership owns a broader portfolio, your OP units may replace concentrated exposure to a single property with an interest in multiple assets. You also give up direct control over the contributed property, so the terms of the operating partnership become an important part of the decision.

Estate planning adds another consideration. Instead of eventually passing a single physical property to your beneficiaries, you may pass OP units. Those interests may be easier to divide among multiple beneficiaries, but their transfer, redemption, valuation, and liquidity depend on the partnership terms.

Bonaventure offers direct 721 contributions as well as a pathway that begins with a 1031 exchange into a DST and may later lead to a qualifying 721 contribution. Eligibility depends on the property, debt, ownership structure, and transaction requirements.

Before proceeding, review the OP-unit distribution and redemption provisions, transfer restrictions, valuation process, debt treatment, portfolio composition, and tax consequences. The key decision is not simply whether you can contribute the property, but whether the OP units you receive are an asset you want to own and eventually pass on.

Trusts

A trust serves a different purpose from a 1031 exchange, DST, or 721 UPREIT transaction. Rather than determining what real estate investment you own next, it establishes how assets are owned, managed, and eventually transferred to your beneficiaries.

For example, a revocable living trust can provide continuity if you become unable to manage your assets and establish instructions for how they pass after death, while generally allowing you to retain control during your lifetime. An irrevocable trust can change ownership and control more substantially, with different gift, estate, and income-tax consequences depending on how it is structured.

That flexibility means a trust can potentially work alongside the investment strategies discussed above. Depending on the structure and governing documents, a trust may hold direct real estate, DST interests, OP units, or other assets. You might first decide what type of real estate investment best fits the next stage of your life, then work with your estate-planning attorney and tax advisor to determine how that asset should be held and transferred.

A trust does not automatically create the same tax deferral available through a qualifying 1031 exchange or 721 transaction. First determine what you want to own, then work with qualified legal and tax advisors to determine how that asset should be held and eventually transferred.

Holding the Property

You do not necessarily have to sell, exchange, or contribute an appreciated property. If the property continues to meet your investment objectives and you want to retain control, holding it may be a reasonable long-term choice.

Estate planning can affect that decision. Under current federal rules, inherited property generally receives a basis equal to its fair market value at the owner's date of death, subject to applicable exceptions. For highly appreciated real estate, this can produce a different capital gains result than transferring the same property during your lifetime.

However, your beneficiaries inherit the property along with the responsibilities that come with it. They may need to manage financing, capital improvements, distributions, and an eventual sale. If several beneficiaries inherit the property together, they will also need to make those decisions jointly.

Before deciding to hold primarily for estate-planning reasons, consider both what your beneficiaries may inherit from a tax perspective and what they will inherit from an ownership perspective. A valuable property may still create complications if the next generation does not want to manage it, cannot easily divide it, or has different plans for the asset.

Plan Before Completing the Transaction

The best time to consider tax deferral and estate planning strategies is before you sell or transfer the property. At that point, you still have the opportunity to consider not only the immediate tax consequences, but also what you want to own next and what you eventually want your beneficiaries to inherit.

Before moving forward, establish your priorities around control, income, management responsibility, liquidity, and future ownership. Then review your property's adjusted basis, embedded gain, existing debt, and ownership structure with your tax and legal advisors. If a 1031 exchange, DST, or 721 UPREIT transaction is under consideration, evaluate the investment on its own merits as well as its role in the broader plan.

Bonaventure works with real estate owners evaluating the transition from directly owned property to professionally managed multifamily investments. With more than 26 years of multifamily experience, approximately $2.9 billion in assets under management, 9,192 units, and more than $615 million of principal capital invested alongside investors, Bonaventure can help you explore 1031, DST, 721 UPREIT, and customized ownership pathways while your tax and legal advisors evaluate the implications for your individual situation.

Discuss Your Real Estate Ownership Transition With Bonaventure

*This article is for educational and informational purposes only and does not constitute tax, legal, or financial advice. Bonaventure does not provide tax, legal, or accounting services. Tax laws and regulations are subject to change, and individual circumstances vary. Investors should consult their own tax advisor, attorney, or qualified intermediary regarding their specific situation before pursuing any of the strategies discussed.