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Tax Deferral Strategies for Clients Selling Investment Real Estate Property

Comparing 1031 Exchanges, Delaware Statutory Trusts (DSTs), 721 UPREITs, and Opportunity Zones

This session explored advanced tax deferral strategies available to clients selling appreciated investment real estate and other highly appreciated assets, with a focus on three primary structures:

• Delaware Statutory Trusts (DSTs) 
• 721 UPREIT transactions 
• Qualified Opportunity Zone (QOZ) investments 

Presented by John Bacigalupi of Cantor Fitzgerald, the discussion emphasized that the most appropriate strategy depends on a client’s goals, liquidity needs, estate planning priorities, time horizon, tax exposure, and risk tolerance. 

A recurring theme throughout the session was that advisors should not approach these structures as interchangeable products. Instead, advisors should understand the unique planning implications, tradeoffs, liquidity constraints, estate considerations, and tax consequences of each approach before recommending them to clients.

The presentation also highlighted the growing importance of integrating real estate tax planning into broader wealth management conversations, especially as many affluent clients hold concentrated positions in appreciated real estate, businesses, or securities. The speakers emphasized that rising tax concerns, aging real estate owners, and estate planning objectives are increasing demand for tax-efficient transition strategies. 

Key Topics and Expanded Insights

1. Understanding the Core Rules of Section 1031 Exchanges

Key Takeaways

• Section 1031 allows investors to defer capital gains taxes when exchanging investment or business-use real estate for “like-kind” real estate. 
• Investors must comply with strict IRS timing and procedural rules. 
• Failure to structure the exchange correctly before closing can permanently eliminate eligibility for tax deferral. 

Important Rules and Technical Requirements

The presenters reviewed several foundational 1031 exchange rules:

45-Day Identification Requirement

Investors have 45 calendar days after selling relinquished property to identify replacement property.

180-Day Exchange Completion Requirement

The replacement property transaction must close within 180 days of the relinquished property sale.

Equal or Greater Value Requirement

To fully defer gain:

• The replacement property must generally be of equal or greater value. 
• Investors must reinvest all net proceeds and replace debt appropriately. 

Qualified Intermediary Requirement

A Qualified Intermediary (QI) must hold proceeds during the exchange period.

A major caution emphasized during the session was that investors cannot take constructive receipt of exchange proceeds. Funds cannot be wired to the client’s personal checking or brokerage account if the investor intends to complete a 1031 exchange. 

Practical Advisor Implications

Advisors should:

• Discuss exchange planning before listing the property. 
• Coordinate early with CPAs, attorneys, and Qualified Intermediaries. 
• Educate clients that missed deadlines cannot generally be corrected retroactively. 

Fact-Check Reference

IRS Like-Kind Exchanges:
https://www.irs.gov/businesses/small-businesses-self-employed/like-kind-exchanges-under-irc-code-section-1031

IRS Publication 544:
https://www.irs.gov/publications/p544

2. Delaware Statutory Trusts (DSTs): Passive Real Estate Ownership with Continued 1031 Eligibility

Overview

The speakers explained that DSTs have become increasingly popular among aging real estate investors who want to preserve tax deferral while eliminating the operational burden of direct property management. 

Under IRS Revenue Ruling 2004-86, beneficial interests in properly structured DSTs qualify as replacement property for 1031 exchanges.

Key Benefits of DSTs

Passive Ownership

DST investors are not responsible for:

• Property management 
• Tenant issues 
• Maintenance 
• Financing negotiations 

This “hands-off” structure was repeatedly positioned as attractive for older investors tired of “tenants, toilets, and trash.” 

Access to Institutional Real Estate

DSTs may provide access to:

• Large multifamily projects 
• Industrial properties 
• Institutional-grade management 
• Potentially more favorable financing 

Lower Investment Minimums

The session noted minimums commonly begin around $100,000.

Continued 1031 Flexibility

One of the most important distinctions emphasized was that DSTs preserve the investor’s ability to perform future 1031 exchanges after the DST property is sold.

Important Drawbacks and Risks

Illiquidity

DSTs are generally long-term illiquid investments, often with projected holding periods of 5–10 years. 

Lack of Investor Control

Investors cannot:

• Make operational decisions 
• Influence management 
• Decide when the property is sold 

Sponsor Risk

The financial strength, experience, and integrity of the sponsor are critical.

Fee Structure

DSTs often involve:

• Acquisition fees 
• Structuring fees 
• Placement fees 
• Asset management fees 

The speakers estimated many acquisition/placement-related fees around 2–2.5%, though fee structures vary by sponsor. 

Estate Planning Implications

DSTs may provide significant estate planning advantages:

• Deferred capital gains during life 
• Potential step-up in basis at death 
• Simplified inheritance of passive real estate interests 

The presenters referenced the common planning phrase “swap until you drop,” describing repeated exchanges throughout life followed by a step-up in basis at death. 

Important Technical Nuance

The step-up in basis rules discussed are based on current federal tax law and may change legislatively in the future.

Fact-Check References

IRS Revenue Ruling 2004-86:
https://www.irs.gov/pub/irs-drop/rr-04-86.pdf

IRS Estate and Gift Tax Overview:
https://www.irs.gov/businesses/small-businesses-self-employed/estate-tax

3. 721 UPREIT Transactions: Converting Real Estate into REIT Ownership

Overview

The session devoted substantial attention to 721 UPREIT structures, which allow investors to exchange appreciated real estate into operating partnership units associated with a Real Estate Investment Trust (REIT). 

Unlike a traditional DST exchange, the investor eventually transitions into REIT ownership.

Key Advantages

Increased Liquidity Potential

Compared with DSTs, UPREIT structures may provide:

• Greater redemption flexibility 
• Potential partial liquidity 
• Easier estate administration 

The presenters highlighted that heirs may benefit from easier liquidation options than with fractional DST interests. 

Diversification

Clients can transition from:

• A single concentrated property
  to 
• A diversified institutional REIT portfolio 

Estate Planning Flexibility

The structure may simplify dividing assets among heirs and improve administrative flexibility.

Critical Drawback: Loss of Future 1031 Eligibility

A major distinction repeatedly emphasized:

• Once investors complete the UPREIT conversion and move into REIT operating partnership units, they generally lose the ability to perform future 1031 exchanges. 

This becomes a defining planning decision.

The Two-Step DST-to-UPREIT Process

The session explained that many sponsors use:

1. A traditional DST acquisition first 
2. Followed by a later conversion into the REIT 

This structure exists because sponsors may not want direct ownership of smaller relinquished properties.

Important Technical Considerations

Holding Period Concerns

The speakers noted that investors typically hold the DST for approximately 2–3 years before conversion to demonstrate investment intent and satisfy IRS expectations. 

Third-Party Valuation

The presenters stressed the importance of independent third-party valuations before UPREIT conversion.

Liquidity Restrictions Still Exist

Although more liquid than DSTs, private REITs often maintain:

• Redemption caps 
• Quarterly liquidity limits 
• Annual repurchase limitations 

Ideal Client Profile

The presenters suggested 721 structures may work particularly well for:

• Clients in their late 70s, 80s, or 90s 
• Investors who never want direct property ownership again 
• Families prioritizing liquidity and estate planning 

Advisor Cautions

Advisors should carefully evaluate:

• Sponsor valuation methodology 
• Liquidity terms 
• Mandatory vs. optional roll-up provisions 
• Client understanding of permanent loss of 1031 flexibility 

4. Qualified Opportunity Zones (QOZs): Tax Deferral and Tax-Free Growth Potential

Overview

Opportunity Zones were established under the Tax Cuts and Jobs Act of 2017 to encourage long-term investment in designated economically distressed communities.

Unlike 1031 exchanges, Opportunity Zones are not limited to real estate gains. 

Eligible gains may include:

• Real estate gains 
• Business sale gains 
• Stock gains 
• Collectibles gains 

The session included a notable example involving appreciated Star Wars memorabilia sold to Disney, illustrating the broad eligibility of capital gains for QOZ treatment. 

Core Tax Benefits

Deferral of Existing Capital Gains

Investors generally have 180 days from the gain event to reinvest eligible capital gains into a Qualified Opportunity Fund (QOF).

Potential Reduction of Deferred Gain

The presenters discussed pending legislative enhancements that could restore partial gain reductions under future law changes.

Tax-Free Appreciation After 10 Years

If held long enough and current rules remain in effect:

• Appreciation within the QOF may become permanently tax-free upon disposition after a 10-year holding period. 

Important Distinction from 1031 Exchanges

With QOZs:

• Only the gain portion must be reinvested. 
• Investors may retain original basis proceeds tax-free. 

Example:

• Property purchased for $5 million 
• Sold for $7 million 
• Only the $2 million gain must enter the QOF 

This distinction can significantly improve liquidity planning. 

Important Risk Considerations

Development Risk

Unlike stabilized DST real estate, many Opportunity Zone projects involve:

• Ground-up development 
• Lease-up risk 
• Construction risk 

The presenters specifically contrasted:

• DSTs purchasing 92–95% occupied properties
  versus 
• Opportunity Zone projects beginning with no occupancy. 

Long Illiquidity Periods

Most Opportunity Zone investments require:

• Approximately 10-year holding periods 
• Significant patience 
• Long-term capital commitment 

Geographic Quality Matters

The speakers strongly emphasized that not all Opportunity Zones are attractive investments.

They noted that while thousands of zones exist nationally, sponsors may only target a small subset of markets with strong demographic and economic characteristics. 

Estate Planning Nuance

A particularly important technical point:

• Heirs inheriting Opportunity Zone investments generally step into the decedent’s holding period. 
• Unlike traditional appreciated assets, heirs may still need to satisfy the remaining holding period requirements to obtain full tax-free appreciation treatment. 

Fact-Check References

IRS Opportunity Zones:
https://www.irs.gov/credits-deductions/businesses/opportunity-zones

IRS Opportunity Zone FAQs:
https://www.irs.gov/credits-deductions/opportunity-zones-frequently-asked-questions

Tax Cuts and Jobs Act:
https://www.congress.gov/bill/115th-congress/house-bill/1

5. Comparing DSTs, 721 UPREITs, and Opportunity Zones

Key Strategic Distinctions

6. Due Diligence and Sponsor Evaluation

Key Advisor Takeaways

The presenters repeatedly emphasized that sponsor quality matters enormously in illiquid alternative investments.

Advisors should evaluate:

• Sponsor financial strength 
• Track record 
• Asset management experience 
• Third-party due diligence 
• Valuation practices 
• Fee structures 
• Liquidity policies 

Important Advisor Caution

The presenters warned against recommending investments solely for tax benefits without evaluating underlying investment quality.

This point was especially emphasized regarding Opportunity Zones. 

Practical Advisor Takeaways

• Begin tax planning discussions before property sales occur. 
• Coordinate closely with CPAs and attorneys. 
• Ensure clients understand liquidity limitations. 
• Carefully distinguish between: 
  • tax deferral, 
  • tax elimination, 
  • and estate planning flexibility. 
• Match strategy selection to: 
  • client age, 
  • income needs, 
  • risk tolerance, 
  • and legacy goals. 
• Evaluate sponsor quality as rigorously as the tax strategy itself. 
• Explain clearly that 721 UPREITs generally terminate future 1031 flexibility. 
• Be cautious about Opportunity Zone investments driven purely by tax incentives rather than investment fundamentals. 
• Use Opportunity Zones thoughtfully for concentrated stock positions and business sales where traditional 1031 exchanges are unavailable. 

External Reference Sources

IRS Like-Kind Exchange Rules
https://www.irs.gov/businesses/small-businesses-self-employed/like-kind-exchanges-under-irc-code-section-1031

IRS Publication 544 – Sales and Other Dispositions of Assets
https://www.irs.gov/publications/p544

IRS Revenue Ruling 2004-86 (DST Guidance)
https://www.irs.gov/pub/irs-drop/rr-04-86.pdf

IRS Opportunity Zones Resource Center
https://www.irs.gov/credits-deductions/businesses/opportunity-zones

IRS Opportunity Zone Frequently Asked Questions
https://www.irs.gov/credits-deductions/opportunity-zones-frequently-asked-questions

U.S. Congress – Tax Cuts and Jobs Act
https://www.congress.gov/bill/115th-congress/house-bill/1

SEC Investor Bulletin on REITs
https://www.sec.gov/resources-for-investors/investor-alerts-bulletins/reits-real-estate-investment-trusts

FINRA Guidance on Real Estate Investment Risks
https://www.finra.org/investors/insights/non-traded-reits

CFP Board Fiduciary and Due Diligence Standards
https://www.cfp.net/ethics/code-of-ethics-and-standards-of-conduct