Each structure has its own set of benefits and trade-offs when selling real estate, but taking advantage of the personal residence exemption is a no brainer if you are eligible
1031 exchanges and Opportunity Zones can make sense if you want to reinvest in real estate, you are okay with a concentrated investment in between 1 and 3 real estate properties, and the personal residence exemption doesn’t cover the majority of the gains
Charitable Remainder Trusts will be a good fit if you are interested in diversifying your investments and the personal residence exemption doesn’t cover the majority of the gains
We’ve had years of record growth, but the stock market swings wildly day to day and a bear market is on the horizon — or may already be here. Real estate, by contrast, hasn’t fallen much if at all. Given these macro conditions, we’ve heard from many investors and operators recently who are looking to take real estate gains off the table.
In our previous article, we told you about four solutions to the high capital gains taxes that accompany real estate sales: the personal residence exemption, Charitable Remainder Unitrusts (and in particular a version called a NIMCRUT), Opportunity Zones, and 1031 Exchanges. Today, we’ll compare these strategies across several useful metrics, including, most importantly, the bottom line: how much you’ll earn over your lifetime using each.
Before we begin, if you need a quick refresher on these structures you can read our previous article here.
Real Estate Tax Planning Strategies
| Personal Residence Exemption | Charitable Remainder Trusts | Opportunity Zone | 1031 Exchange | |
| When is this used? | After selling your personal residence | Before the property is sold | After an asset is sold but within 180 days of the sale | Immediately after selling your property |
| Primary tax benefit | Individuals can exclude up to $250,000 of capital gains, while a married couple can exclude up to $500,000, provided that they meet certain criteria | Defer federal and state taxes on the property sale | Defer taxes on capital gains income until 2027; avoid taxes on further gains from OZ investment (if held for 10+ years) | Defer capital gains taxes on property sale |
| Liquidity | 100% up front | Can receive a % of the trust assets every year or defer the distributions | Typically no liquidity for at least 5 years and potentially 10 years | No liquidity until the sale of the second property |
| Common issues | If your capital gains are significantly larger than your exemption, you can still face a big tax bill | Don’t have access to all the sale proceeds upfront | Your investment is more volatile because it is concentrated in a single asset class and geography — and in a limited number of properties | Your investment is more volatile because it is concentrated in a single property |
Comparing the return on investment (ROI) of each structure
Let’s start with our goal and a few baseline assumptions.
Goal: Evaluate each of these tax planning structures based on post-tax return on investment after 20 years.
Baseline Assumptions:
- Bryan and Hannah are 35 years old, married, and based in California, and they are planning to sell a $5m property with a $1m cost basis.
- They expect to be hit with a 37% tax rate (because all of their earnings will be long-term capital gains). As a result, they would owe around $1.5 million in state and federal taxes on their sale (37% of their $4 million capital gain).
- They expect the stock market to grow 10.5% annually (based on historical S&P returns), while an opportunity zone investment and a 1031 investment might appreciate 9% annually (based on historical REIT returns).
- This also assumes a base level of expenses for each strategy.
Returns:
The returns from each strategy are relatively similar, which just means that your goals and assumptions about the future are critical to your choice. (We’ll articulate some of the reasons why you may choose one strategy over another below)
- Unitrust (or CRUTs): $22.6 million (along with an additional $5m charitable donation that can go to your favorite charity or your own Donor Advised Fund or Foundation)
- 1031 Exchange: $23.4 million
- Opportunity Zone: $21.3 million
- Personal Exemption: $20.4 million
- No Structure: 19.4 million
When to use these different real estate tax planning strategies?
Personal residence exemption. This is the most straightforward tool. If your property qualifies and your gains are lower than the exemption, you can claim this deduction — it’s a no brainer. If the gain is significantly higher than your exemption (or your property does not qualify) then you should start to look at the other alternatives.
When looking at the other alternatives, the big questions are:
- Do you want to reinvest exclusively in real estate (and, if so, do you want to manage the investment yourself)?
- At what rate do you expect real estate to grow annually, as compared to other asset classes (like stocks)?
Other options. If you want to invest in non-real estate investments, expect other asset classes to outperform real estate or are charitably inclined you should look at Charitable Remainder Trusts. If, instead, you want to reinvest in real estate, two options that may make sense are Opportunity Zones or using a 1031 exchange. An Opportunity Zone may make sense if you do not want to choose and manage the real estate investment yourself while a 1031 exchange could be a fit if you want to choose and manage the real estate directly.
Next Steps
Real estate is rare among capital assets, in that there are a number of viable options for tax planning. Each strategy has merits and drawbacks, and each could be a fit for you depending on the asset’s past appreciation and your investment preferences and growth expectations. There’s no “one size fits all” solution, and the right choice will be depend on your personal preferences and tax position.
Schedule a time to chat with our team or get started setting up your trust (at no cost and with no commitment)
About Valur
We built a platform to give everyone access to the tax and wealth building tools of the ultra-rich like Mark Zuckerberg and Phil Knight. We make it simple and seamless for our customers to take advantage of these hard to access tax advantaged structures so you can build your wealth more efficiently at less than half the cost of competitors. From picking the best strategy to taking care of all the setup and ongoing overhead, we make it easy and have helped create more than $500m in wealth for our customers.