Seven Ways To Reduce Capital Gains Tax on Real Estate

If you’ve built wealth through real estate, selling a property can feel like a double-edged sword. On the one hand, you’re unlocking capital for new opportunities. Conversely, capital gains tax on real estate sales can take a massive bite out of your profits — federally, you could pay up to 37%. In addition to this, many states impose their own capital gains tax. 

The good news? There are legal, tax-efficient strategies to manage your tax bill when divesting of real estate. Whether you’re looking to reinvest, simplify your portfolio, or transition into more passive income, here are seven proven ways to dispose of real estate while managing taxes.

#1 1031 Exchange

A 1031 exchange allows you to sell a property and reinvest the proceeds in another “like-kind” property while deferring capital gains taxes. This strategy is particularly useful for investors looking to upgrade properties, shift to a different market, or consolidate their portfolio without incurring an immediate tax burden. However, strict IRS rules apply — among them, you must identify a replacement property within 45 days and complete the purchase within 180 days to qualify. 

Here is a hypothetical example. An investor wants to sell an apartment building purchased initially at $750k and currently valued at $2M. They exchange it for a $3M commercial property using a 1031 exchange, effectively deferring capital gains tax on $1.25M. 

#2 Delaware Statutory Trust (DST)

Some investors decide they no longer want to manage their real estate but have long-term embedded gains. A Delaware Statutory Trust (DST) offers a solution in this case. DSTs allow investors to pool resources into institutional-grade real estate — such as office buildings, multifamily properties, and medical centers — without having to deal with the operational responsibilities of ownership. 

A DST qualifies as a 1031 Exchange replacement property, meaning you can sell a property and reinvest in a DST. Additionally, DSTs provide passive income through rental distributions, offering an attractive alternative for investors who prefer hands-off investing in real estate. 

Here is a hypothetical example. A retiring investor sells a rental property and reinvests into a DST, gaining steady income while eliminating management responsibilities. This allows for a seamless transition from active real estate ownership to a more passive approach, reducing the day-to-day stress of property management or oversight.

#3 Qualified Opportunity Zone (QOZ) Funds

Qualified Opportunity Zones (QOZs) offer investors a compelling incentive: the ability to defer capital gains taxes until December 31, 2026, by reinvesting those gains into a QOZ fund. Even more appealing, if the investment is held for at least 10 years, any gains on the new QOZ investment may be completely tax-free. 

But here’s the nuance: while the law provides this favorable treatment, it’s not automatic. Investors must meet eligibility criteria, follow strict timing requirements, and ensure the investment complies with ongoing program rules. Plus, the long-term benefits are subject to the continuation of the QOZ program itself. 

In short, while QOZs present a powerful planning opportunity, it’s essential to approach them thoroughly to understand the requirements, not just the headline tax breaks. 

These funds are designed to spur economic development in designated Opportunity Zones, offering significant tax advantages to investors willing to hold assets long-term. 

Here is a hypothetical example. A business owner sells a company and reinvests $5M of gains into a QOZ Fund in June 2025. They can defer paying taxes on these gains until 12/31/2026, and if they remain invested until June 2035, they will not pay taxes on the appreciation of the investment. This strategy is particularly attractive for investors looking to diversify into development projects while promoting tax efficiency. 

#4 Charitable Remainder Trust (CRT)

If you’re philanthropically inclined, a Charitable Remainder Trust (CRT) allows you to donate real estate or other appreciated assets, avoid capital gains taxes, and receive income for a specified period of time. With a CRT, the donor transfers property into the trust, sells it tax-free, and gets income from the trust’s investments. Upon the donor’s passing or the trust’s expiration, the remaining assets go to a designated charity. 

#5 Installment sales (seller financing)

When selling a real estate investment, instead of taking a lump sum (and its attendant tax bill), an installment sale (or seller financing) allows you to spread taxable gains over several years, reducing your tax burden each year. By structuring the sale as a long-term agreement, sellers can recognize income over multiple tax periods, avoiding a one-time capital gains hit. 

Here is a hypothetical example. A seller finances the sale of their $3M rental property to the buyer over 10 years, reducing their yearly taxable income while collecting principal and interest payments from the loan. This approach can be particularly useful for those looking to maintain a steady cash flow for several years while reducing tax exposure. 

#6 Gifting and estate planning

If your real estate portfolio is part of your legacy, strategic gifting can help you transfer wealth while paying attention to estate and capital gains taxes. Using tools like Trusts, Family Limited Partnerships (FLPs), and Grantor Retained Annuity Trusts (GRATs), you can help your real estate holdings pass tax-efficient to your heirs. 

A well-planned estate transfer can reduce taxes while keeping assets within the family. Additionally, under current IRS rules, property passed on at death receives a step-up in basis, meaning heirs inherit the asset at its market value at the time of passing, which can avoid capital gains taxes altogether should the heir decide to sell.

#7 Capital gains exclusion for primary residence sales

If selling your primary residence, you may qualify for a $250,000 (single) or $500,000 (married) capital gains tax exemption under IRS rules. This exclusion applies to homeowners who have lived in their home for at least two of the last five years before the sale. 

Here is a hypothetical example. A homeowner sells a house for $1.2M (bought at $600K) and excludes $500K in capital gains taxes, reducing their tax bill to nearly zero.  

Choose the best tax strategy for your goals

Divesting from real estate without a tax strategy can cost you significant unnecessary taxes. Which approach to implement depends on your goals —whether you want liquidity, passive income, or a tax-efficient legacy plan. Understanding the various tax-advantaged strategies allows you to make informed decisions that protect and grow your wealth. 

If you’re considering a real estate sale, consult with your financial advisor, tax professional, and estate planning attorney to explore the best options to leverage available tax benefits on your taxes when divesting from real estate. 

This content is for informational and educational purposes only and should not be construed as individualized advice or a recommendation for any specific product, strategy, or course of action. Brighton Jones, its affiliates, and employees do not provide personalized investment, financial, tax, or legal advice through this communication. This material is not intended to, and does not, create a fiduciary relationship under ERISA or any other applicable law. For individualized advice tailored to your specific circumstances, please consult with your adviser.