Tax-Advantaged Investment Strategy for Real Estate

Tax drag is the recurring loss of capital to taxation that would otherwise stay invested and compound. It repeats at every distribution, every disposition, and every transition, chipping away at the base on which future gains are earned. Every dollar paid to taxes is a dollar that is no longer invested and compounding. A tax-advantaged investment strategy reduces that drag and keeps more capital invested over time.

This article covers three such strategies as they apply to a multifamily real estate portfolio: depreciation, deferral through a 1031 exchange or Delaware Statutory Trust, and a 721 UPREIT exit option, plus the long-duration ownership that lets them compound. It also shows how stacking them preserves more capital than any single strategy could alone.

Strategy One: Depreciation During the Hold

Depreciation is the first strategy in the stack because it works every year an investor holds the property, regardless of whether they sell, exchange, or continue owning the asset.

Real estate owners can deduct the cost of the building over time because the tax code treats the structure as wearing out, even if the property's market value stays flat or increases. For multifamily assets, residential rental property is depreciated on a straight-line basis over 27.5 years↟ under the Modified Accelerated Cost Recovery System (MACRS). Land is not depreciable↟ because it does not wear out.

How the annual deduction works

Assume a multifamily property is purchased for $2,000,000, with $1,600,000 allocated to the building and $400,000 allocated to land. The building allocation generates approximately:

For a top-bracket Virginia investor, that deduction is worth roughly:

These figures are illustrative. Actual tax benefits depend on the investor's income, filing status, passive activity loss rules, basis, at-risk limitations, state tax treatment, and whether depreciation is later recaptured at sale.

Where cost segregation fits

Cost segregation increases early-year deductions by separating certain building components into shorter recovery periods. Examples include:

• Flooring
• Fixtures and cabinetry
• Appliances
• Site improvements

Under the One Big Beautiful Bill Act↟, 100% bonus depreciation is permanent for qualifying property acquired and placed in service after January 19, 2025. Components identified through cost segregation that carry a recovery period of 20 years or less can be deducted in full in the year they are placed in service.

The reinvestment effect

Depreciation keeps more cash in the portfolio rather than sending it to taxes each year. Using the same example, if the investor reinvests approximately $24,900 in annual tax savings at a 5% annual return, those reinvested savings grow to roughly $313,000 after 10 years.

That is why depreciation is the quietest but most consistent tax-efficiency tool in real estate investing. It does not depend on a sale. It works during the hold period, year after year.

Strategy Two: Deferral at Transition (1031 and DST)

Depreciation reduces taxes during the holding period, but it also creates a future tax liability. When an investment property is sold, investors may owe:

• Federal capital gains tax on appreciation
• Federal depreciation recapture tax (up to 25%)↟
• The 3.8% Net Investment Income Tax (when applicable)
• State income tax on the taxable gain

Rather than paying those taxes immediately, many investors choose to defer them through a Section 1031 exchange, allowing more capital to remain invested and continue compounding.

Section 1031 Exchange

Section 1031 of the Internal Revenue Code allows investors to defer federal capital gains tax and depreciation recapture by exchanging one qualifying investment or business-use real property for another qualifying like-kind property. The exchange is governed by two statutory timing requirements↟:

• Identification Period: The replacement property must be identified in writing within 45 days of transferring the relinquished property.
• Exchange Period: The replacement property must be acquired before the end of the exchange period, which ends on the earlier of 180 days after the transfer or the due date (including extensions) of the taxpayer's federal income tax return.

To receive full tax deferral, investors generally must reinvest all exchange proceeds into qualifying replacement property of equal or greater value and avoid receiving taxable "boot."

The deferred taxes are not forgiven. Instead, they carry forward through a lower tax basis in the replacement property. The primary benefit is that capital, which would otherwise be paid in taxes, remains invested and continues compounding.

Delaware Statutory Trust (DST)

A Delaware Statutory Trust (DST) provides a passive way to complete a Section 1031 exchange.

Under IRS Revenue Ruling 2004-86↟, a beneficial interest in a qualifying DST is treated as an ownership interest in real property for Section 1031 purposes.

Rather than purchasing and managing another property directly, an investor can exchange into a DST and:

• Maintain 1031 eligibility
• Continue deferring capital gains and depreciation recapture taxes
• Eliminate day-to-day property management responsibilities
• Access institutional-quality real estate under professional management

The Disposition Decision: Three Paths at Year 10

The illustration below assumes:

• Property value after 10 years: $2,688,000
• Original purchase price: $2,000,000
• Building basis: $1,600,000
• Ten years of straight-line depreciation

*Assumes a fully tax-deferred exchange with no taxable boot received.

Illustrative example only. Assumes 10 years of straight-line depreciation ($58,182 annually on a $1,600,000 building basis), a 20% federal long-term capital gains tax rate, the 3.8% Net Investment Income Tax where applicable, a 25% federal depreciation recapture rate, and Virginia's 5.75% individual income tax. Actual tax consequences depend on an investor's basis, exchange structure, state of residence, closing costs, and other factors. Investors should consult a qualified tax advisor.

In this illustration, a taxable sale immediately removes approximately $382,000 from the investment portfolio, while both Section 1031 strategies allow the full $2,688,000 to remain invested.

Strategy Three: The 721 UPREIT Exit Option

The Section 721 UPREIT contribution is the final layer of the tax-efficiency strategy. It is designed for investors who are ready to exit active property ownership while continuing to defer the taxes accumulated through years of appreciation and depreciation.

How it works

Section 721 of the Internal Revenue Code generally allows an owner to contribute qualifying investment real estate to a REIT's operating partnership in exchange for Operating Partnership (OP) units without recognizing taxable gain at the time of the contribution.

Instead of selling the property, the investor exchanges direct ownership for an ownership interest in the operating partnership. The deferred gain carries forward into the OP units, allowing the investor to transition from a single actively managed property to a diversified, professionally managed real estate portfolio. In Bonaventure's case, that portfolio is BMIT®↜, a non-traded, perpetual-life NAV REIT holding two dozen multifamily communities1 across multiple Virginia submarkets and select Southeast markets. An investor whose property fits BMIT's portfolio can contribute it directly into the operating partnership in exchange for OP units. Others reach BMIT after completing a 1031 exchange into a Bonaventure multifamily DST, with any later 721 contribution treated as a separate, independent decision that cannot be pre-arranged.

What a 721 contribution provides

The Strategic Trade-Off

A Section 721 contribution is generally considered a one-way transition. Once real estate has been contributed to a UPREIT operating partnership, investors generally cannot exchange their OP units back into directly owned real estate through another Section 1031 exchange.

For that reason, many investors view a 721 contribution as the final step in a long-term tax strategy:

1. Generate annual tax savings through depreciation.
2. Preserve investment capital through one or more Section 1031 exchanges, including Delaware Statutory Trusts when passive ownership is preferred.
3. Transition into a UPREIT when the goal shifts from active ownership to long-term passive income, diversification, and estate planning.

The Foundation: Long-Duration Ownership

Holding assets for the long term isn't a fourth strategy. It is the foundation that allows the other three to work.

The greatest tax benefits often come from allowing depreciation, appreciation, and tax deferral to work together over an extended holding period rather than treating real estate as a series of short-term investments. Time is what allows each layer of the tax-efficiency stack to compound.

• Depreciation generates annual tax deductions throughout the holding period, helping shelter a portion of rental income each year.
• Section 1031 exchanges preserve investment capital by deferring taxes that would otherwise be paid every time a property is sold.
• A Section 721 UPREIT contribution is generally most valuable after years of appreciation and tax deferral have accumulated.
• Under current federal law, holding appreciated assets until death may allow heirs to receive a step-up in basis, potentially eliminating the deferred capital gain and depreciation recapture for income tax purposes.

Frequent buying and selling can interrupt that compounding process. Every transaction introduces costs, execution risk, and the possibility that a planned tax-deferral strategy cannot be completed. A failed Section 1031 exchange, for example, may result in immediate recognition of capital gains and depreciation recapture.

Selling a property also replaces its existing depreciable basis with a new one. While a replacement property creates new depreciation opportunities, investors may give up future deductions tied to the property they sold and reduce the amount of capital available to compound after accounting for transaction costs and taxes. In many cases, the most effective way to maximize after-tax wealth is not through frequent trading but by holding high-quality real estate assets long enough for depreciation, appreciation, and tax deferral to reinforce one another.

The Tax-Advantage Stack Across the Asset Lifecycle

The table below maps each layer to the phase of the asset lifecycle where it operates. Long-duration ownership spans all four phases because it is the condition that enables the others, not a step in the sequence.

The long-duration ownership row spans all four phases: it is the surface the stack rests on, not a step in it.

What Stacking Produces Over 30 Years

Layering these strategies across a full investment lifecycle reveals their cumulative effect. The two paths below start from the same $2,000,000 investment and the same underlying property performance. The only variable is the tax strategy.

Exhibit B. Two Paths Over 30 Years (Virginia Investor)

*Step-up in basis at death eliminates remaining deferred tax. If the investor converts OP units or sells before death, deferred tax becomes due at that point. Annual income is also partially sheltered by depreciation throughout the hold, reducing cumulative income tax paid relative to the tax-naive path.

The roughly $1,790,000 difference in terminal value is not a return premium. It is the cumulative cost of tax-naive portfolio management: capital that paid taxes instead of compounding. Adding Virginia's state tax to the picture widens the gap from what federal taxes alone would produce, because the optimized path defers nearly all of it while the tax-naive path pays at every sale.

Keep More Capital Compounding With Bonaventure's Integrated Platform

Each layer of the tax-efficiency stack builds on the one before it, and the sequence matters. A misstep at any transition can reduce the tax benefits accumulated over years of ownership.

For example:

• Selling without completing a Section 1031 exchange generally accelerates the recognition of capital gains and depreciation recapture that could otherwise have remained deferred.
• Contributing property to a Section 721 UPREIT is typically a long-term exit strategy. Once property is contributed, investors generally cannot exchange their OP units into directly owned real estate through a subsequent Section 1031 exchange.
• Selling too early may shorten the period over which investors benefit from depreciation deductions and reduce the long-term compounding effect of depreciation, appreciation, and tax deferral working together.

Viewed individually, each strategy provides a meaningful tax benefit. Coordinated across the full lifecycle of a multifamily investment, they can help investors preserve more capital, extend tax deferral, and maximize the amount of wealth that remains invested over time.

Bonaventure supports investors throughout that lifecycle, offering tax-advantaged multifamily investment opportunities, Section 1031 exchanges, Delaware Statutory Trusts (DSTs), and Section 721 UPREIT exit solutions in an integrated platform.

To explore which combination of strategies may fit your investment goals, speak with the Bonaventure team.

This article is for educational and informational purposes only and is not intended to be all-inclusive and may be changed at any time without notice or obligation to update. This article does not constitute tax, legal, or financial advice. Bonaventure does not provide tax, legal, or accounting services. Tax laws and regulations are subject to change, and individual circumstances vary. Investors should consult their own tax advisor, attorney, or qualified intermediary regarding their specific situation before pursuing any of the strategies discussed.

↟These articles were produced by an independent third party. These articles should not be considered a solicitation or recommendation. Any such recommendation or solicitation would be made under separate cover. We do not endorse or accept responsibility for the content of any third-party website.

↜This material is not an offer to sell or a solicitation of an offer to buy any interest in the Bonaventure Multifamily Income Trust or any fund sponsored by Bonaventure or its affiliates. Any offering is made only pursuant to a confidential private placement memorandum (PPM) and related offering documents, which should be reviewed in full and which control in the event of any inconsistency with this material. Certain statements are forward-looking and subject to risks and uncertainties. BMIT interests are not registered under the Securities Act of 1933 or any state securities laws, and BMIT is not registered under the Investment Company Act of 1940. Securities offered through Preferred Capital Securities, member FINRA/SIPC.

1) As of 06/30/26.

THE RISKS ASSOCIATED WITH INVESTING IN A REAL ESTATE PRIVATE EQUITY FUND GENERALLY INCLUDE:

Limited Regulatory Oversight - Since private equity funds are typically private investments, they do not face the same oversight and scrutiny from financial regulatory entities such as the Securities and Exchange Commission ("SEC") and are not subject to the same regulatory requirements as regulated investment companies, including requirements for such entities to provide certain periodic pricing and valuation information to investors. Private equity offering documents are not reviewed or approved by the SEC or any US state securities administrator or any other regulatory body. Also, managers may not be required by law or regulation to supply investors with their portfolio holdings, pricing, or valuation information.

Strategy Risk - Many private equity funds employ a single investment strategy. Thus, a private equity fund may be subject to strategy risk, associated with the failure or deterioration of an entire strategy.

Use of Leverage and Other Speculative Investment Practices - Since many private equity fund managers use leverage and speculative investment strategies such as options, investors should be aware of the potential risks. When used prudently and for the purpose of risk reduction, these instruments can add value to a portfolio. However, when leverage is used excessively and the market goes down, a portfolio can suffer tremendously. When options are used to speculate (i.e., buy calls, short puts), a portfolio's returns can suffer and the risk of the portfolio can increase.

Past Performance - Past performance is not necessarily indicative and is not a guarantee of a private equity fund's future results or performance. Some private equity funds may have little or no operating history or performance and may use hypothetical or pro forma performance that may not reflect actual trading done by the manager or advisor and should be reviewed carefully. Investors should not place undue reliance on hypothetical or pro forma performance.

Limited Liquidity - Investors in private equity funds have limited rights to transfer their investments. In addition, since private equity funds are not listed on any exchange, it is not expected that there will be a secondary market for them. A private equity fund's manager may deny a request to transfer if it determines that the transfer may result in adverse legal or tax consequences for the offering.

Tax Risks - Investors in certain jurisdictions and in private equity funds generally may be subject to pass -through tax treatment on their investment. This may result in an investor incurring tax liabilities during a year in which the investor does not receive a distribution of any cash from the Fund. In addition, an investor may not receive any or only limited tax information from private equity funds may not receive tax information from underlying investments in a sufficiently timely manner to enable an investor to file its return without requesting an extension of time to file.

Reliance on Fund Manager; Lack of Transparency - A private equity offering's manager or general partner has total investment authority over the private fund. There is often a lack of transparency as to a private equity offering's underlying investment. Because of this lack of transparency, an investor may be unable to monitor the specific investments made by the offering or to know whether the investments are consistent with the sponsor's historic investment philosophy or risk levels.

Due to the risks mentioned above, it is important to perform proper due diligence in evaluating and choosing private equity managers to place your money with. There have been occasions when private equity fund managers took on too much risk in their portfolio and lost a substantial amount of their investors' money.