Smart Real Estate Tax Moves for High-Income Investors

If you’re a high-earner building wealth through real estate, tax planning isn’t optional—it’s essential. Rental properties, depreciation, and capital gains rules can work in your favor, but only if you know how to use them. Without a plan, you might be overpaying.

This article focuses on real estate investing for high-net-worth individuals and the tax strategies that can reduce, defer, or completely eliminate certain liabilities. If you're earning over $400K per year or your net worth is seven figures and up, you're probably already subject to higher taxes under current law. Real estate, done right, can help shift those outcomes.

Here are key strategies high-income investors should understand:

1. Know How the IRS Classifies Real Estate

The IRS taxes real estate differently based on your activity. Flipping homes? Expect ordinary income taxes. Holding rentals long-term? You may qualify for lower capital gains rates and benefit from depreciation and deductible expenses like interest, insurance, and maintenance.

But there’s a catch: passive activity loss limits. Unless you meet specific income thresholds or qualify as a real estate professional, you can’t always use real estate losses to offset other income.

2. Use Depreciation to Offset Taxable Income

Depreciation allows you to deduct the value of the building (not the land) over time—27.5 years for residential or 39 for commercial. For large properties, this deduction adds up. You can also accelerate depreciation with cost segregation, which breaks assets into shorter timelines (5 to 15 years). Combined with bonus depreciation, this can significantly reduce your taxable income early on.

3. Defer Taxes with 1031 Exchanges

Want to sell a property without paying capital gains taxes right away? A 1031 exchange lets you reinvest the profits into a similar property and defer taxes. There are strict timelines (45 days to identify and 180 days to close), and any cash taken out may be taxed.

Retiring or stepping back? Consider rolling your exchange into a Delaware Statutory Trust (DST). It offers passive income and tax deferral without management headaches.

4. Watch the Net Investment Income Tax

High earners may owe an extra 3.8% Net Investment Income Tax on rental profits and gains. If you qualify as a real estate professional (750+ hours annually and more time in real estate than anything else), you may avoid this.

5. Use Step-Up in Basis for Estate Planning

Hold onto a property until death, and your heirs may receive a “step-up” in basis, resetting the property’s value to market rate—eliminating capital gains. It’s a powerful wealth transfer tool, though it may be targeted in future tax changes.

6. Don’t Ignore State-Level Taxes

Federal tax breaks only go so far. States like California and New York hit real estate income and gains hard. Forming LLCs in tax-friendly states won’t help unless your property or income is located there.

For high-net-worth investors looking to exit an active management role, this strategy pairs well with a Delaware Statutory Trust (DST). You can 1031 your apartment building into fractional ownership of institutional-grade real estate with zero management responsibilities. It's not perfect for everyone - but if you're heading into retirement and don’t want to pay a massive tax bill, it’s worth understanding.

7. Get Expert Help

As highlighted by Fragasso Financial Advisors in their article on passive income planning, smart investors don’t go it alone. They use strategies like DSTs, cost segregation, and real estate-focused estate planning—before transactions happen.

Final Tip

Mistakes are costly. Waiting until after a sale or trusting a generalist CPA can limit your options. Plan early, know the rules, and build a team with experience in real estate tax planning. That’s how you keep more—and pass it on.

Investment advice offered by investment advisor representatives through Fragasso Financial Advisors, a registered investment advisor.