Tax Deferral & Exclusion Strategies: Key Sections of the Internal Revenue Code
Navigating tax deferral and exclusion strategies can feel overwhelming, but the right approach can help you preserve wealth and maximize investment opportunities. Below, we break down some of the most valuable sections of the Internal Revenue Code (IRC)—making complex tax strategies clear and actionable.
Section 1031 – Like-Kind Exchange of Investment Property
A 1031 exchange enables real estate investors to defer capital gains taxes by swapping one investment or business-use property for another of "like-kind." To qualify, the proceeds from the sale of the relinquished property must be reinvested into a qualifying replacement property within 180 days. The primary benefit of a 1031 exchange is the deferral of taxes, allowing investors to preserve their equity and continue growing their real estate portfolio. To ensure compliance with the exchange rules, a Qualified Intermediary (QI) is required to facilitate the transaction.
Section 1032 – Exchange of Corporate Stock for Property
Corporations can issue stock in exchange for property without recognizing any gain or loss, offering a tax-efficient way to raise capital. This provision encourages business growth while avoiding immediate tax liability, providing a method for companies to restructure or expand. Unlike 1031 exchanges, however, this section applies to corporate stock transactions and not real estate.
Section 1033 – Involuntary Conversions (Eminent Domain & Disasters)
When property is forcibly taken through eminent domain, a natural disaster, or theft, owners can defer capital gains taxes by reinvesting the compensation proceeds into a property of similar use. The deadlines for reinvestment are two years for property lost due to natural disasters and three years for property taken via condemnation or eminent domain. This provision helps protect property owners from unexpected tax burdens resulting from involuntary loss. Unlike 1031 exchanges, a Qualified Intermediary is not required in a 1033 exchange.
Section 1035 – Exchange of Life Insurance, Endowment, or Annuity Contracts
Section 1035 allows policyholders to exchange a life insurance policy, annuity, or endowment contract for another without triggering taxable gains. This strategy enables individuals to upgrade to better financial products without facing an immediate tax burden. However, exchanges must be direct; funds cannot be received in cash before reinvestment. This provision only applies to insurance products and does not require a Qualified Intermediary.
Section 721 – Tax-Deferred Contribution of Property to a REIT or Partnership
Investors can exchange real estate for ownership shares in a Real Estate Investment Trust (REIT) or partnership without triggering immediate taxes. This is commonly used when investors wish to transition from direct property ownership to a more liquid, diversified investment in a REIT, often referred to as an UPREIT exchange. However, once the property is converted into REIT shares, investors lose the eligibility for future 1031 exchanges.
Section 453 – Installment Sales (Capital Gains Deferral via Seller Financing)
By structuring a sale as an installment sale, a seller can spread capital gains taxes over multiple years, rather than paying them all at once. In an installment sale, the seller finances part of the sale and receives payments over time, recognizing gains proportionally as payments are received. This method is commonly used in business sales, real estate transactions, or any asset sale where seller financing is involved. It allows the seller to stay in a lower tax bracket by avoiding a large one-time capital gain.
Tax Exclusion Strategies
Section 121 – Exclusion of Capital Gains on the Sale of a Primary Residence
Homeowners can exclude up to $250,000 in capital gains (or $500,000 for married couples) from taxation when selling their primary residence, provided they have owned and lived in the property for at least two of the last five years. This exclusion can be used once every two years, offering substantial tax savings to homeowners. It replaced the now-repealed Section 1034, which allowed a tax deferral option instead.
Section 1034 – Rollover of Gain from Sale of a Primary Residence (Repealed)
Before its repeal in 1997, Section 1034 allowed homeowners to defer capital gains by purchasing another home of equal or greater value within two years of selling their primary residence. This provision has since been replaced by Section 121, which offers a direct exclusion of capital gains rather than a deferral.
Other Tax-Deferral & Tax-Exclusion Strategies
✔ Qualified Opportunity Zones (QOZs): Investors can defer capital gains by reinvesting in designated Opportunity Funds, with potential tax-free appreciation after 10 years.
✔ Charitable Remainder Trusts (CRTs): Allows donors to contribute appreciated assets to a charitable trust, receive an income stream, and defer capital gains taxes.
✔ Retirement Accounts (401(k), IRAs): Traditional retirement plans defer taxes on earnings until withdrawals begin.
✔ Structured Sales: Similar to installment sales, but often involve an annuity structure to spread out tax liability.
