Tax Efficient Ways to Exit Real Estate Holdings

By Julie Baird, President, First American Exchange Company

for Wealth Management 2025 Market Outlook

Many baby boomers who have invested in real estate assets now find themselves asset-rich thanks to potentially sizable property portfolios, but also cash-poor. Other boomers may be looking to simplify their holdings or transition to more liquid investments. Either way, selling real estate comes with the drawback of capital gains and depreciation recapture taxes, which can sharply reduce the equity available for reinvestment.

One way to address this challenge is to consider strategies, such as 1031 exchanges, which allow boomers to defer taxes indefinitely, or until a lower tax bracket applies, through reinvestment in “like-kind” properties. Other options they can consider include installment sales, establishing charitable remainder trusts, or leveraging the primary residence exclusion by converting a 1031 exchange acquired investment property into a primary residence before selling.

Investors should always consult their tax professional and legal counsel when evaluating their options, but let’s explore how 1031 exchanges and other complementary strategies can help boomers exit real estate holdings effectively.

Flexibility and Estate Planning

Under IRC Section 1031, investors can defer capital gains taxes when exchanging real property held for investment or business purposes for another “like-kind” property. All U.S. real estate is considered like-kind, including in certain circumstances the U.S. Virgin Islands, Guam and Northern Mariana Islands, which provides flexibility for investors seeking to adjust their portfolio.

Using 1031 exchanges can also be an effective estate planning tool for boomers who hold investment properties through repeat 1031 exchanges until death. Upon passing, heirs receive the property at a stepped-up basis, resetting the property’s value to its fair market value at the time of inheritance. This eliminates capital gains taxes on the deferred gains and allows heirs to sell the property with minimal tax liability. This strategy allows boomers to generate income during their lifetime, while also preserving wealth for the next generation.

An Installment Sale or Charitable Remainder Trust

An installment sale allows sellers to avoid a large, taxable lump sum by receiving payments over time, spreading income and tax liability across several years while earning interest. However, it requires careful planning to meet IRS rules, with taxes due annually on received payments.

A Charitable Remainder Trust is another option and enables sellers to transfer real estate into a trust, sell it tax-efficiently, and receive lifetime income through distributions. Sellers also benefit from a charitable tax deduction, with the remaining assets going to a designated charity after their death. This option can also be complex and costly to set up.

Leveraging IRC Sections 121 and 1031

Boomers can also reduce taxes by combining the benefits of IRC Sections 121 and 1031. By acquiring a property through a 1031 exchange and later converting it to a primary residence (living in it for at least two of the five years preceding the sale), a seller can exclude up to $250,000 (single) or $500,000 (married) of capital gains under Section 121 — reducing their taxes significantly.

Whichever strategy a boomer chooses to transition out of their real estate holdings, it is important to mitigate the tax impact of their investment. A team comprising a qualified intermediary, attorney, tax analyst and real estate broker can help a real estate investor navigate regulations and optimize their strategy to reach specific financial goals and establish a legacy.