Deferring Capital Gains Taxes on Investment Property
August 5, 2026
Deferring capital gains taxes on investment property is one of the most effective ways for real estate investors to preserve capital and sustain long-term income. When an appreciated property sells, federal capital gains tax, depreciation recapture, and the net investment income tax can together claim a substantial share of the proceeds, reducing the capital available to reinvest. Deferral strategies allow investors to roll the full sale value into the next opportunity rather than the after-tax remainder.
This piece compares the primary real estate strategies investors use to defer capital gains taxes on investment property: 1031 exchanges, Delaware Statutory Trusts (DSTs), 721 UPREIT transactions, and Qualified Opportunity Zones (QOZs). It quantifies the difference each makes in after-tax proceeds, reinvestment capital, and long-term income potential.
The Cost of Not Deferring
Consider a Virginia investor selling an appreciated multifamily property, owned free and clear, for $2 million, with a $1 million total gain. Of that gain, $300,000 reflects depreciation claimed over the hold period, and $700,000 reflects appreciation. For a high-income investor, the combined federal and state tax consequences at sale are significant.
Side-by-side: taxable sale vs. deferred exchange
| Taxable Sale | Deferred Exchange | |
|---|---|---|
| Sale price | $2,000,000 | $2,000,000 |
| Depreciation recapture tax (federal, 25% on $300K) | $75,000 | $0 |
| Capital gains tax (federal, 20% on $700K) | $140,000 | $0 |
| Net investment income tax (federal, 3.8% on $1M) | $38,000 | $0 |
| Virginia state tax (5.75% on $1M) | $57,500 | $0 |
| Total tax owed | ~$310,500 | $0 |
| Capital available to reinvest | ~$1,689,500 | $2,000,000 |
Deferring the gain keeps roughly $310,500 working in the next investment instead of going to taxes. Over time, that preserved capital can compound when invested in a new property, which is where the long-term advantage becomes clear. The figures above reflect maximum federal rates for a high-income investor, a 25% depreciation recapture rate*, a 20% long-term capital gains rate, the 3.8% net investment income tax, plus Virginia’s 5.75% tax*, which treats capital gains as ordinary income. Actual tax treatment varies by income level and state, so investors should consult a tax advisor to model their specific situation.
*This article was produced by an independent third party. This article should not be considered a solicitation or recommendation. Any such recommendation or solicitation would be made under separate cover. We do not endorse or accept responsibility for the content of any third-party website.
Comparing Strategies for Deferring Capital Gains Taxes On Investment Properties
Each capital gain deferral strategy has trade-offs related to taxes, reinvestment capital, management responsibility, liquidity, and the type of investor it best suits. Reinvestment and after-tax figures follow the Virginia example above.
| Strategy | Tax Deferred | Reinvestment Capital | Ongoing Management | Liquidity / Exit | Best Fit |
|---|---|---|---|---|---|
| Outright sale | No | ~$1.69M | None; exits real estate | Fully liquid immediately | Investors who want cash regardless of the taxes due |
| 1031 into replacement property | Yes1 | Full $2M | Active; sources acquisition and manages the property | Illiquid until next sale or refinance | Investors who want to defer taxes and still want direct ownership and control |
| 1031 into a DST | Yes1 | Full $2M | Passive; professionally managed | Illiquid; typical 5-10 year hold | Investors who want to defer taxes and want passive management |
| 721 UPREIT | Yes | Full $2M | Passive; REIT-managed | OP units may be redeemed for cash periodically, subject to terms and limits | Investors who want to defer taxes, want passive management, investment diversification, and estate planning advantages |
| Qualified Opportunity Zone | Yes, gain only2 | Gain portion only | Active; development or substantial improvement | Illiquid; 10-year hold for full exclusion | Investors with gains from any source seeking QOZ development |
Notes
¹ Full deferral requires acquiring a replacement property of equal value or greater. Trading down or taking cash out creates taxable “boot.”
2 A QOZ defers only the gain, not the full sale value. QOZ programs follow specific rules that depend on investment date. Refer to current QOZ regulation for details.
The after-tax figure reflects the Virginia example above, including state tax. Tax treatment depends on individual circumstances and state of residence. Investors should consult a qualified tax advisor before pursuing any deferral strategy.
The right strategy for deferring capital gains taxes on investment property depends on what the investor wants next: to keep building, to step back from management, to diversify, or to shelter a gain that did not come from real estate at all. Each option below leads with the situation it solves.
1031 Exchange
If an investor wants to trade up, stay hands-on, and keep building a real estate portfolio, a 1031 exchange is the foundation. It lets them sell an investment property and reinvest the proceeds into a like-kind replacement property, deferring capital gains and depreciation recapture taxes when the full proceeds are reinvested into property of equal or greater value. The investor has 45 days to identify a replacement and 180 days to close. Exchanges can be repeated indefinitely, and a step-up in basis at death can eliminate the deferred taxes entirely for heirs, depending on the ownership structure.
Example. An investor has owned a small apartment building for years and has built up substantial equity. They want to move into a larger property in a stronger market, but selling outright would trigger capital gains tax and depreciation recapture, leaving a smaller amount to put toward the next purchase. Instead, they sell and exchange into the larger building within the 45-day identification and 180-day closing windows. The full proceeds carry forward, the taxes are deferred, and the investor continues to control and manage the new asset, free to exchange again down the road.
Choose this if: you want direct ownership and control, and you intend to keep building an actively managed real estate portfolio over time.
Look elsewhere if: you no longer want to source and close the 1031 acquisition, actively manage the property, or manage capital events.
Delaware Statutory Trusts: A Passive Way to Complete a 1031
The hardest part of a 1031 exchange is often the timeline: you have 45 days to identify a replacement property and 180 days to close on it. A Delaware Statutory Trust can ease that pressure, because DST interests are pre-packaged and readily available, so they can be identified and closed quickly within those windows. A DST is not a separate strategy from a 1031 exchange, but one of the most common ways to complete one passively.
A DST typically holds institutional-quality real estate and qualifies as like-kind replacement property. A DST structure allows investors to use the 1031 exchange to acquire fractional ownership in a pre-assembled real estate investment, deferring the same capital gains and depreciation recapture that they would if they bought a replacement property themselves. This allows investors to acquire real estate without taking on direct property management or sourcing the replacement property themselves.
Example. An investor has owned a rental fourplex for two decades. It has appreciated, and the mortgage is paid off, but they are tired of tenant calls, repairs, and turnover. Selling outright would mean a significant tax bill across federal and state taxes, and completing a 1031 exchange entirely on their own would still require finding and managing a replacement property on a tight clock.
Instead, they exchange into a DST. The taxes are deferred as part of the transaction, and a professional sponsor takes over the day-to-day management. The primary trade-off they accept is giving up control of the asset in exchange for passive income and management.
Choose this if: you want to defer taxes without sourcing and executing a traditional acquisition yourself, stay invested in real estate, and never field a tenant call again.
Look elsewhere if: you want control over the asset, or might need your capital back before the typical five to ten-year hold.
721 UPREIT Transactions
If an investor is done managing real estate but not done deferring taxes, a 721 UPREIT trades control for diversification. The investor contributes property into a real estate investment trust’s operating partnership in exchange for operating partnership (OP) units, deferring capital gains and depreciation recapture taxes, effectively converting their ownership in a single property into a passive interest in the REIT’s larger portfolio.
Beyond deferral, the structure adds diversification and estate planning flexibility, since OP units are divisible among heirs who may also still receive a step-up in basis depending on the investors’ ownership structure. In a scenario where a property owner has multiple investors, the 721 exchange structure can also allow each individual investor to make their own independent decisions with their OP units, as opposed to being tied together by an individual property.
Example. An investor approaching retirement holds a single appreciated property and has several adult children. A single property is hard to divide cleanly among heirs, and the investor no longer wants to manage it. By contributing the property to a REIT’s operating partnership, they exchange the actively-managed individual asset for a diversified, passive one.
The OP units typically generate distributions and can be evenly allocated among heirs for estate planning purposes. The distributions provide passive income that occurs on a scheduled basis. REIT’s typically have redemption options, which would allow each individual heir the opportunity to decide whether they want to stay invested in the portfolio or redeem units for cash.
Choose this if: you are ready to step back from active management, want diversification across a portfolio of properties, and are coordinating with estate planning.
Look elsewhere if: you still want active management or the ability to execute a future 1031 exchange, since the contribution is often irreversible.
Qualified Opportunity Zones (QOZs)
If a gain came from selling stock, a business, or another non-real-estate asset, a QOZ is the one option here that still works. Investors reinvest capital gains from any source into a Qualified Opportunity Fund that develops or improves property in a designated zone. In multifamily, this usually means ground-up development or substantial rehabilitation rather than stabilized acquisitions. Ground-up multifamily development is, in fact, among the most common QOZ deployment paths, and an operator with end-to-end development and management capabilities is well positioned to execute these projects across the long QOZ hold period.
Unlike a 1031, a QOZ defers only the gain, not the full sale value, and it can carry development or heavy value-add risk. Its distinct advantage is that appreciation on a QOZ investment held for at least ten years can be fully excluded from tax. The rules are mid-transition: investments through December 31, 2026, follow the original program, while investments after that date follow updated rules with a rolling five-year deferral and a 10% basis step-up at five years.
Example. An investor sells a stock or business and faces a large capital gain, and since it is not real estate held for investment purposes, a 1031 exchange is off the table. A QOZ is the one option that can fit, because it accepts gains from any source. The investor reinvests the gain into a Qualified Opportunity Fund developing real estate such as multifamily housing in a designated Opportunity Zone. They often take on development or heavy renovation risk and a long hold period, but if the investment is held for at least ten years, the appreciation on the QOZ investment can be excluded from tax entirely, a benefit none of the other strategies offer.
Choose this if: your gain came from any source, you are comfortable with development or heavy value-add exposure, and you can commit to a ten-year hold for the full exclusion.
Look elsewhere if: you want to reinvest the full after-tax sale value, avoid development risk, or need a shorter time horizon.
When Custom Solutions Make Sense
Standardized 1031 and DST structures work well for most investors. But some transactions are too complex for an off-the-shelf solution, and forcing one into a standard structure can mean a worse outcome or a missed deferral.
Custom structuring usually makes sense when a transaction involves one or more of the following:
- Multiple properties sold or exchanged on coordinated timing. Aligning several 1031 exchanges within the 45-day and 180-day windows is far harder than handling a single sale, and a missed deadline on any one property can trigger tax on that piece.
- Significant debt that must be replaced. Full deferral requires replacing the debt on the relinquished property, and larger or unusual loan structures often need a tailored replacement plan rather than a standard one.
- More than one structure working together. A transaction might begin with a 1031 into a DST and later involve a separate, optional 721 UPREIT decision, and sequencing those correctly requires planning that an off-the-shelf product does not provide.
- A disposition that has to align with estate and wealth transfer planning. When the goal is passing assets to heirs efficiently, a 721 UPREIT or a DST may need to coordinate with the broader estate plan, not just defer the current tax.
- Larger transactions, generally $7 million or more. At this scale, the structuring decisions carry more weight, and small differences in how the 1031, DST, or 721 UPREIT is built can have a meaningful effect on the after-tax result.
At this level of complexity, the value lies less in the strategy itself and more in the sponsor’s ability to build a transition around the specific situation, combining 1031 exchanges, DSTs, and 721 UPREIT structures as the transaction requires. This is where working with a sponsor that structures custom solutions, rather than only standardized products, makes a difference.
Preserving Capital When Selling Appreciated Real Estate
The structures in this deferring capital gains taxes on investment property guide work best when executed by a sponsor who does so every day. Meeting deadlines, structuring the debt replacement, sequencing decisions correctly, and building custom solutions when a transaction does not fit a standard mold are what turn a sound strategy into a completed transaction.
Bonaventure offers 1031 exchanges, DSTs, and 721 UPREIT transactions within a single platform, along with custom structured solutions for larger or more complex transactions. With over $1.6 billion in total deferred exchange value across 42 completed exchange transactions and over $600 million of its own capital co-invested alongside clients, Bonaventure brings the execution experience these decisions require.