Tax Strategies for Financial Advisors

Many financial advisors work with clients who have accumulated substantial wealth in real estate. These properties may generate reliable income and represent years of disciplined investing. Still, they can also create a significant deferred tax liability, concentration in a single asset or market, ongoing management responsibilities, and limited liquidity.

Advisors evaluating these situations must balance several competing priorities. A client may want to defer taxes while reducing management responsibilities, improving diversification, generating passive income, or creating a smoother estate transition. This is where tax strategies for financial advisors become part of broader portfolio planning. The ownership structure chosen can influence each of those outcomes.

This article examines the primary real estate ownership structures financial advisors evaluate: direct replacement property, DSTs, 721 UPREIT transactions, and partial 1031 exchanges.

Tax Strategies for Financial Advisors at a Glance

The table below compares the primary ownership structures used in tax strategies for financial advisors. It highlights how each approach differs in liquidity, diversification, management responsibilities, and continued real estate exposure.

The 1031 Exchange: A Deferral Mechanism

Section 1031⥉ allows investors to defer capital gains tax by exchanging investment real estate for qualifying like-kind real property. Since 2018, Section 1031 has applied only to real property. In a typical delayed exchange, a qualified intermediary holds the sale proceeds while the investor identifies and acquires replacement property. The investor generally has 45 calendar days to identify potential replacement properties and 180 calendar days to complete the exchange. To defer the full gain, investors generally must reinvest all net proceeds and avoid receiving cash, non-like-kind property, or uncompensated debt relief.

Advantages

• A 1031 exchange allows clients to preserve more capital by deferring, instead of immediately recognizing, capital gains tax on qualifying transactions.
• Since taxes remain deferred, more equity can stay invested in real estate, potentially increasing purchasing power and supporting long-term wealth accumulation.
• The like-kind standard is broad, allowing investors to transition among many types of investment real estate while maintaining tax deferral when IRS requirements are met.

Considerations

• A 1031 exchange defers taxes rather than eliminating them. Deferred gain generally carries forward to the replacement property and may be recognized in a future taxable disposition unless another qualifying exchange occurs or another tax rule applies.
• The exchange must satisfy strict IRS requirements, including the use of a qualified intermediary and compliance with the 45-day identification and 180-day exchange deadlines.
• Receiving cash or other non-like-kind property generally results in taxable boot to the extent of realized gain.

Best Suited For

A 1031 exchange is generally best suited for clients who want to remain invested in real estate while deferring current tax liability. It provides the foundation for several ownership strategies, including direct replacement property, DST replacement property, and, in some cases, a later transition into a 721 UPREIT structure. The following sections examine those ownership structures in greater detail.

Direct Replacement Property

A direct replacement property allows a client to complete a 1031 exchange by purchasing another investment property that they own directly. The client retains responsibility for selecting the property, arranging financing, overseeing operations, making capital improvements, and determining when to sell. If the replacement property is later exchanged through another qualifying 1031 transaction, the tax deferral may continue.

Advantages

• Direct ownership provides the highest degree of control, because the client makes all investment and operational decisions.
• It allows the client to implement their own investment strategy, continue claiming available depreciation deductions, and retain flexibility over the property's eventual disposition.
• Because the replacement property remains eligible real estate, it may qualify for a future 1031 exchange if IRS requirements continue to be met.

Considerations

• Greater control also means greater responsibility. The client must either manage the property directly or oversee third-party management, complete due diligence within the exchange timeline, and remain responsible for financing, leasing, maintenance, and other ownership decisions.
• Reinvesting in a single replacement property may leave the client concentrated in one asset or market.
• Although the client controls when to sell, direct real estate is generally illiquid, and accessing a portion of the property's value often requires refinancing or a taxable sale.

Best Suited For

Direct replacement property is generally best suited for clients who want to maintain active ownership, value control over investment decisions, and are comfortable with the management responsibilities and concentration risk that often accompany direct real estate ownership.

DSTs as Replacement Property

IRS Revenue Ruling 2004-86⥉ provides that an interest in a properly structured Delaware Statutory Trust (DST) may be treated as direct ownership of the underlying real estate for Section 1031 purposes. This allows investors to exchange into fractional interests in institutional-quality properties while a professional sponsor manages the real estate on behalf of all investors. Clients may also allocate exchange proceeds across multiple DST offerings to diversify their real estate holdings and keep the full value of their equity invested in Real Estate rather than potentially sending a portion to the IRS.

Advantages

• DSTs offer a passive ownership structure that eliminates the day-to-day responsibilities associated with direct property ownership.
• They can simplify exchange execution because interests are typically offered in set investment amounts, making it easier to invest all exchange proceeds.
• In many cases, debt held at the trust level can help satisfy debt replacement requirements without requiring the investor to obtain new financing personally.
• Diversifying across multiple DST offerings may reduce concentration in a single property or market.

Considerations

• The passive nature of a DST comes with reduced control. To preserve its tax treatment under Revenue Ruling 2004-86, the trustee's authority is intentionally limited, and a DST generally cannot accept additional investor capital, reinvest proceeds from a property sale, freely refinance debt, or make significant operational changes to the property.
• DST investments are generally illiquid. Although sponsors often target holding periods of five to 10 years, the timing of a sale is not guaranteed, secondary markets are limited, and distributions depend on the property's financial performance rather than being guaranteed.
• DST interests are securities, and investment eligibility depends on the applicable securities exemption and offering documents. Bonaventure's current DST offerings require accredited investor status and generally have a $100,000 minimum investment.

Best Suited For

DST replacement property is generally best suited for clients who want to preserve 1031 tax deferral while transitioning from active property management to passive real estate ownership. It may also appeal to investors seeking broader diversification without assuming responsibility for day-to-day property operations.

721 UPREIT Structures

Under Section 721, contributing property to a partnership in exchange for a partnership interest generally does not trigger immediate gain recognition and keeps the full value of an investor's equity invested in Real Estate rather than potentially sending a portion to the IRS. In a UPREIT transaction, a property owner contributes qualifying real estate to a REIT's operating partnership and receives operating partnership (OP) units in exchange. The operating partnership determines which properties it will accept based on factors such as property type, market, size, condition, and debt profile. In exchange, the owner transitions from direct ownership of a single property to an ownership interest in the operating partnership's broader real estate portfolio.

Advantages

• A 721 UPREIT can reduce concentration risk by replacing ownership of a single property with an interest in a diversified portfolio of real estate assets.
• It allows clients to transition from active property management to passive ownership while generally continuing to defer taxes on the contributed property.
• Depending on the partnership agreement, OP units may provide a future path to liquidity through redemption or conversion to REIT shares.

Considerations

• A 721 contribution is generally the final step in a tax-deferred transition, because OP units are partnership interests instead of real property and therefore cannot be exchanged through another Section 1031 transaction.
• A redemption for cash or exchange for REIT shares generally triggers recognition of the deferred gain, and the operating partnership's taxable sale of the contributed property may also allocate built-in gain to the contributor.
• Future liquidity depends entirely on the partnership agreement and may be subject to holding periods, program limits, approval requirements, available funds, or other restrictions. Redemption opportunities should not be viewed as guaranteed.

Best Suited For

A 721 UPREIT is generally best suited for clients who want to transition away from direct property ownership while maintaining long-term exposure to institutional real estate through a diversified portfolio. It may also appeal to investors who have already completed a 1031 exchange and, if the opportunity arises, later participate in a separate Section 721 transaction through a DST. Because the operating partnership is not obligated to acquire a DST's underlying property, this secondary pathway should be viewed as a potential future opportunity rather than an expected outcome.

Partial-Liquidity Transactions

A partial 1031 exchange allows a client to reinvest only a portion of the sale proceeds into qualifying replacement property while retaining some cash at closing. The cash retained, known as boot, is generally taxable in the year of the exchange to the extent of the realized gain, while the gain associated with the qualifying replacement property may continue to be deferred.

Advantages

• A partial exchange provides immediate liquidity without requiring the client to recognize all deferred gain at once.
• The retained cash can be used for retirement income, debt reduction, estate equalization, or other investment opportunities, while the remaining equity continues to benefit from tax deferral through the replacement property.

Considerations

• Receiving boot reduces the amount of gain eligible for tax deferral and decreases the client's continued investment in real estate.
• Advisors should evaluate whether the immediate liquidity justifies the current tax liability and whether the remaining real estate allocation continues to support the client's long-term investment objectives.

Best Suited For

A partial 1031 exchange is generally best suited for clients who need immediate access to a portion of their equity but still want to defer taxes on the balance of their real estate investment. It can be an effective solution when a client's objectives include generating cash while maintaining continued exposure to investment real estate.

Matching the Structure to the Client

After understanding how each ownership structure works, the next step is determining which approach best aligns with the client's financial objectives. While more than one option may be appropriate, the client's liquidity needs, desired level of control, tax considerations, and long-term investment goals often narrow the available choices. The matrix below summarizes common client scenarios and the ownership structures financial advisors may evaluate.

The matrix is intended as a planning guide and not a decision rule. More than one ownership structure may satisfy a client's objectives, and each option should be evaluated in light of the client's tax position, income needs, investment time horizon, estate plan, and risk tolerance. Coordinating with tax, legal, and investment professionals can help ensure the selected structure supports the client's broader financial plan.

A Multi-Pathway Approach to Real Estate Tax Strategies

Bonaventure supports several ownership transitions, including DST replacement properties, 721 UPREIT contributions into BMIT®, direct co-investments, and custom structures for more complex transactions over $7M. This range allows advisors and clients to evaluate the structure against the client's tax position, liquidity needs, ownership goals, and long-term plan.

The firm brings 26 years of multifamily experience and works with advisors, CPAs, estate-planning counsel, and qualified intermediaries to coordinate the execution of transactions.

Contact Bonaventure to evaluate ownership structures for a specific client situation

This article is for educational and informational purposes only and not intended to be all-inclusive and may be changed at any time without notice or obligation to update. It 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.

⥉The articles linked throughout were produced by an independent third parties and 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. 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. No securities regulator has approved or passed upon the accuracy of this material. Securities offered through Preferred Capital Securities, member FINRA/SIPC. Certain statements are forward-looking and subject to risks and uncertainties.

DISCLOSURES

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.