Real Estate

A collection of strategies to help business owners keep more of their wealth.

Key numbers

The tax code treats real estate investors exceptionally well. Two strategies in particular — depreciation and the 1031 exchange — can shelter a significant amount of income and defer gains potentially forever.

Depreciation

When you own rental property, you get to deduct the cost of the building (not the land) over its useful life — 27.5 years for residential, 39 for commercial. On a $1M property with $800K allocated to the structure, that's roughly $29,000 per year in non-cash deductions. The property could be appreciating in value the whole time, but the deduction still reduces your taxable rental income.

The catch: when you sell, the IRS recaptures those deductions at 25%. So if you took $200,000 in depreciation and then sell, $200,000 of your gain is taxed at 25% rather than the standard capital gains rate. That's manageable — but it's real, and it changes the sale math.

Cost segregation

Cost segregation accelerates the timeline. An engineering study can reclassify portions of the property (fixtures, appliances, land improvements) into shorter depreciation categories — 5, 7, or 15 years instead of 27.5. On a large property, this can dramatically front-load deductions into the first few years. This is a tool worth running on any commercial or large residential property you hold.

The 1031 Exchange

When you sell an investment property, you normally owe capital gains tax on the appreciation plus depreciation recapture. The 1031 exchange defers all of it.

Here's how it works: you sell your property, have a qualified intermediary hold the proceeds, identify a replacement property within 45 days, and close on it within 180 days. The gain from the sale carries over as a lower basis in the new property — you didn't avoid the tax, you deferred it to the future.

Then you do it again. And again. Each time you exchange, the deferred gain rolls forward. You could buy a rental property today, exchange into a larger one in five years, exchange again in another ten, and never pay a dollar in capital gains tax.

What happens to all that deferred tax at death? It disappears. The step-up in basis at death resets the cost basis of inherited real estate to the current fair market value. Heirs inherit the property at full value with no capital gains tax owed on all the appreciation and all the deferred 1031 gain. The combination of 1031 exchanges throughout life and a step-up at death is one of the most effective wealth transfer tools available.

The rules are strict. The exchange must be like-kind (investment property to investment property — your primary residence doesn't qualify). The timeline doesn't flex. And you can't touch the proceeds; they must go through a qualified intermediary. But within those rules, the 1031 exchange is remarkably powerful.