6 Real Estate Investment Strategies and Their Tax Implications

Real estate offers multiple avenues for investors to build wealth, ranging from hands-on rentals to passive syndications. In this episode, we’ll explore six prominent strategies—long-term rentals, short-term rentals, small partnerships, syndications/funds, REITs, and DSTs—and highlight key tax considerations for each.

1. Long-Term Rentals

Long-term rentals are the classic “buy-and-hold” strategy, where tenants typically sign 12-month leases. Investors benefit from steady cash flow and depreciation deductions that often shelter a large portion of the rental income.

Long-term rental income isn’t subject to self-employment tax, which reduces the tax burden compared to running many other small businesses.

Another perk is the ability to use a 1031 exchange to defer capital gains when you sell, though liquidity is limited and you’ll manage (or supervise) tenant and property issues.

2. Short-Term Rentals

Short-term rentals (e.g., Airbnb, VRBO) often bring higher nightly rates but require hands-on operations—frequent turnovers, cleaning, and guest communication.

Despite the extra work, the “short-term rental loophole” can be attractive if the average guest stay is under seven days and you meet material participation rules, because you may be able to offset W-2 or business income with those rental losses.

Like long-term rentals, income is typically not subject to self-employment tax, but you must invest considerable time to maintain high occupancy and meet the loophole’s requirements.

3. Small Partnerships

Small partnerships (two to five investors) blend direct ownership with shared capital and responsibilities.

You can implement cost segregation or 1031 exchanges if everyone agrees, though disagreements sometimes arise about when to refinance or sell. Still, small partnerships allow more control than larger-scale funds, letting you actively shape decisions like property improvements and exit timing.

4. Syndications & Funds

Syndications and funds let you invest passively in larger deals, often led by a general partner (GP) who sources and manages properties such as apartment buildings, mobile home parks, or commercial spaces.

While you receive a share of cash flow and depreciation via a K-1, you sacrifice control—liquidity is locked until the GP refinances or sells. You can’t usually apply the short-term rental loophole or real estate professional status to your share, since you’re a passive limited partner.

This approach works well for those seeking truly hands-off investing, albeit with less direct decision-making power.

5. REITs (Real Estate Investment Trusts)

REITs resemble stocks: you buy shares on the public market and can sell them at any time. This liquidity can be appealing if you want to avoid the long hold periods common in real estate.

However, REIT dividends are taxed at ordinary income rates (though part may be a return of capital), and you can’t offset REIT income with your rental losses because REIT dividends count as portfolio (non-passive) income.

REITs do qualify for the QBI deduction (up to 20% of the dividend), offering a partial tax advantage over some other equity investments.

6. DSTs (Delaware Statutory Trusts)

DSTs, approved by the IRS for 1031 exchanges, allow multiple investors to hold fractional interests in real estate while preserving direct property ownership for tax purposes. T

They’re often used as a backup when a direct replacement property for a 1031 exchange falls through, or when investors want a passive approach without losing the ability to keep exchanging in the future.

Though fees can be higher and returns may be modest, DSTs can ensure you maintain the option to perform a 1031 exchange later, since you’re treated as owning real estate rather than a partnership interest.

Key Takeaways

Each strategy carries unique trade-offs in terms of control, liquidity, and tax advantages.

Direct ownership (long-term or short-term rentals) can unlock powerful benefits like cost segregation and the short-term rental loophole, but it also demands more effort and oversight.

Small partnerships strike a balance between collaboration and control, while syndications and funds remove day-to-day responsibility in exchange for less say in operational decisions.

REITs deliver high liquidity but dividends face ordinary tax rates, and DSTs serve as a specialized 1031-friendly vehicle for those seeking a passive role with continued tax deferral options.

Choosing the right path depends on your goals: Do you want to minimize hands-on involvement?

Are you looking for maximum liquidity, or do you prefer total control? Do you have a looming 1031 deadline? A proactive approach—consulting a qualified tax professional, mapping out your timeline, and clarifying your tolerance for risk—ensures you match your objectives to the right real estate investment method.

Looking for proactive real estate tax advice?

• We’re hiring for CPAs and EAs who love real estate. Email onboarding@hallcpallc.com.
• Now accepting new clients for 2024. Book a discovery call at therealestatecpa.com/podcast.

By clarifying how involved you want to be, how quickly you might need your capital, and how much control you desire, you’ll pinpoint a real estate strategy—and its tax benefits—that best aligns with your overall financial goals.

Get started on optimizing your portfolio with a tax strategist. Reach out today.

Transcript

0:00 – 0:31 | Introduction & Episode Overview

Thomas Castelli, CPA (00:00.632)
Hey, thanks for tuning into this episode of the TaxSmart REI podcast. Today, we’re going to be going through an overview of the various investment strategies that exist in the real estate space, and the different tax benefits and implications you can expect from each. This was a request from a long-time TaxSmart REI podcast listener, so a quick shout-out to you!

We’ll be covering:

• Direct Ownership: long-term rentals, short-term rentals, small partnerships
• Syndicates & Funds
• REITs
• DSTs
  …and a few other things along the way. We’ll dive into all that in just one minute.

0:32 – 1:25 | Welcoming Justin Shore & Defining Direct Ownership

Thomas Castelli, CPA
All right, and we are back. Today I’m joined by Justin Shore, Advisory Manager here at our firm. We’re going to start with direct ownership. Generally, that’s where you get the most tax benefits, and the more active you are, the greater those benefits can be.

Just to clarify what we mean by “direct ownership”: you’re either buying the property in your own name (or with a spouse if you’re married) or as part of a small partnership with a few people. Justin, any thoughts?

Justin Shore (01:26.352)
Yes, I’d basically say this is when you’re in the driver’s seat—calling all the shots about management, repairs, improvements, choosing tenants, etc. So you have a lot of control.

1:26 – 4:05 | Long-Term Rentals: Liquidity & Tax Basics

Thomas Castelli, CPA (01:42.308)
Exactly. First up: long-term rentals, which we’re defining as rentals with 12-month leases. On the liquidity side, you can decide when to sell, but it’s not something you can offload at the click of a button—like you could with publicly traded stock.
From a tax perspective, the rental income typically faces ordinary income rates (up to 37%), but very often depreciation can help shelter that income. When you eventually sell, you’ll deal with capital gains and depreciation recapture. One major plus is that long-term rental income isn’t subject to self-employment tax. Justin, anything else?

Justin Shore (02:35.804)
No self-employment tax is huge. If you just compare this to starting a side business—like landscaping, for instance—you’d have to pay another 15.3% in self-employment tax on top of ordinary income. With rental real estate, you avoid that, so it’s pretty advantageous.

4:06 – 5:02 | Deductions & Active Participation

Thomas Castelli, CPA (04:05.06)
You can deduct property expenses (mortgage interest, property taxes, repairs, utilities, etc.). But to apply net rental losses against W-2 or other active income, you have to meet certain conditions:

1. Special $25,000 Loss Allowance: requires “active participation” and stays intact up to certain income limits.
2. Real Estate Professional Status (REPS): 750 hours + more than half your work time + material participation in your rentals.

Justin Shore
Right. People often ask if forming an LLC changes which deductions they get, but generally it doesn’t. An LLC mainly helps with liability protection. We just discourage putting rentals in an S corporation or C corporation.

5:03 – 6:18 | Short-Term Rentals: Overview & “Loophole”

Thomas Castelli, CPA (05:03.42)
Moving on to short-term rentals, which are a big favorite lately. Similar to long-term rentals in that you’re taxed at ordinary rates and you don’t pay self-employment tax. But short-term rentals can unlock the so-called STR “loophole”: if your average guest stay is seven days or less and you meet one of the material participation tests, you might offset W-2 or business income without needing REPS.

Justin Shore
But it’s definitely more work—turnover, cleaning, marketing. You might spend 5x the hours you would on a long-term rental. Yet that can mean bigger tax benefits, so it’s about what you’re willing to handle.

6:19 – 8:06 | BRRRR & 1031: More Direct Ownership Benefits

Thomas Castelli, CPA (06:19.106)
Another big benefit of direct ownership is the BRRRR strategy—Buy, Rehab, Rent, Refinance, and Repeat. You create equity through renovations, then refinance to pull out cash tax-free and keep the property. Plus, you can do 1031 exchanges much more easily when you’re the sole owner (or part of a small group) because you have direct say in buying or selling.

Justin Shore
Exactly. With multiple partners or a syndication, 1031s get complicated. Same for large refinances—the group has to agree. Direct ownership gives you freedom to say, “I want to refinance now” or “I want to sell now.”

8:07 – 9:26 | Small Partnerships

Thomas Castelli, CPA (08:07.644)
If you’re in a small partnership—maybe 2 to 5 partners—many of the same rules and benefits apply (like cost segregation, 1031). But it can get more complicated if only some partners want to 1031 and others don’t. Still, you’re generally closer to the driver’s seat than if you invest in a large fund.

Justin Shore
Exactly. Less flexibility than being fully on your own, but you still have a good bit of control if the partnership is small.

9:27 – 10:32 | Syndicates & Funds: Liquidity & Tax

Thomas Castelli, CPA (09:27.496)
Now let’s talk syndicates and funds. These are typically large partnerships run by a general partner (GP) who controls acquisition, management, and eventual sale. As a limited partner (LP), you’re passive—so you have very limited control. From a liquidity standpoint, you can’t just exit whenever you want. Often you might have to wait for the project’s sale or accept a buyout discount.

Tax-wise, you receive a K-1 reflecting your share of income, expenses, depreciation. But the short-term rental loophole, active participation, or real estate professional benefits don’t usually apply if you’re truly passive.

10:33 – 14:20 | Syndication Nuances: Refinances & Planning

Justin Shore (10:33.628)
Yes. Some syndications do a value-add and refinance, returning a portion of capital to LPs, but that’s at the GP’s discretion. You can’t force a 1031 if the GP decides to sell. And you’ll have to carefully time tax-planning measures—like offsetting gains—since you don’t control the exit date.

Thomas Castelli, CPA
Exactly. That’s the trade-off: it’s largely hands-off, which people like, but you lose control of the asset. If you want autonomy over dispositions and refinances, direct ownership or small partnerships are better.

14:21 – 16:18 | REITs: High Liquidity, Different Tax Profile

Thomas Castelli, CPA (14:21)
Next up, REITs (Real Estate Investment Trusts)—often publicly traded, so you get high liquidity. You can buy or sell shares in your brokerage account in seconds. But you’re subject to the stock market’s ups and downs.

Tax-wise, dividends from REITs are taxed at ordinary rates rather than the lower qualified dividend rate—though part of the dividend might be a return of capital. Also, you can get a 20% QBI deduction on REIT dividends. But you cannot offset REIT dividends with passive losses from your rentals because REIT dividends count as portfolio income.

Justin Shore
Right, that’s a big distinction. The REIT itself doesn’t pay corporate tax, so you get higher distributions, but you’re taxed at ordinary income instead of the special dividend rate.

16:19 – 18:08 | UpREITs & 721 Exchange

Justin Shore
A particular variant is an UpREIT, where you can do a 721 exchange by contributing property you own into the REIT partnership. It’s pretty advanced, but it allows deferral of capital gains. Not everyone can do it—you need the right property the REIT actually wants.

Thomas Castelli, CPA
Exactly. It’s a specialized strategy, but it’s out there for those with large holdings that fit a REIT’s profile.

18:09 – 20:04 | Delaware Statutory Trusts (DSTs)

Thomas Castelli, CPA (18:09.724)
Finally, let’s talk Delaware Statutory Trusts (DSTs). These are IRS-blessed as valid like-kind (1031) exchange vehicles. So if you sell your rental property, you can roll the proceeds into a DST. This is similar to a syndication in that you’re passive, but for tax purposes, you’re considered to hold direct real estate. Therefore, if the DST later sells, you can 1031 again.

Justin Shore
Yes, many investors use DSTs as a “backup plan” for 1031 if their primary replacement property falls through. The downside? Typically higher fees, potentially lower returns, and you have no day-to-day say. Still, it’s a lifesaver if you need a quick 1031 match. Also, DSTs often invest in Class A properties (Walgreens, etc.), so the upside might be limited, but they can be stable.

20:05 – 25:00 | Comparing Control, Liquidity & Tax Benefits

Thomas Castelli, CPA
So, stepping back for a moment, you see a spectrum of control vs. effort vs. tax benefits:

• Direct Ownership: Most control, big potential tax benefits (like cost seg, STR loophole, REPS), but you handle day-to-day or manage property managers.
• Small Partnerships: Still decent control, but you must coordinate with partners.
• Syndications/Funds: Very hands-off, limited control, potential K-1 losses, but can’t do personal 1031 easily.
• REITs: Super liquid, minimal control, dividends taxed at ordinary rates, partial QBI benefit.
• DSTs: Good 1031 tool, hands-off, but higher fees and less upside.

Deciding which is best depends on your personal goals, risk tolerance, and time commitment.

Justin Shore
Right. Some folks want total freedom from landlord duties—they pick REITs or syndications. Others want to drive every decision—they go direct ownership. And you can mix strategies, too, depending on what you’re aiming to achieve.

25:01 – 30:00 | Detailed Tax Considerations & Strategies

Thomas Castelli, CPA
Let’s drill a bit deeper into how to handle tax strategies across these different models. For instance:

• Cost Segregation: If you own a property directly or via a small partnership, you can do a cost seg study to accelerate depreciation. In a syndication, the sponsor usually decides if or when to do it. REITs handle depreciation internally; you don’t see that breakdown individually.
• Bonus Depreciation: Phases down after 2023, but still an option. Again, direct owners control that decision. Syndicate investors rely on the GP.
• Exit Timing: If you’re a direct owner, you can time a sale for year-end or wait if your income is high in a given year. With syndications, you get what you get.

Justin Shore
Yes, plus a note about carrying forward losses. If you’re passive in a syndication and have suspended passive losses, you must wait until the final property sale or generate other passive income to unlock them. With direct ownership, you can plan partial property dispositions, refinances, etc.

30:01 – 35:00 | Estate Planning & Asset Protection

Thomas Castelli, CPA
A quick tangent on estate planning: If you own multiple properties directly, you might structure them using various LLCs or trusts for liability or inheritance planning. With syndications, you own LP shares, which can go to your heirs, but it’s simpler to have it spelled out in your trust documents. REITs are basically stock you can pass down. DST interests can also be inherited. The stepped-up basis rules might apply differently, but generally, real estate held at death can benefit from that step-up, including DSTs.

Justin Shore
Right, there are subtle differences in the time it takes for your heirs to gain control of a DST or a syndication share. But overall, real estate is real estate—even if held via a pass-through. Always confirm with an estate attorney, because each vehicle can have different rules for transfer, capital accounts, etc.

35:01 – 38:00 | Deeper Look at Partnerships vs. Syndicates

Thomas Castelli, CPA
Let’s revisit the line between a small “joint venture” vs. a full-blown syndication.

Usually, in a JV:

• You have a few partners who are all somewhat active.
  Everyone might be signing on the loan.
• All partners share decisions.

In a syndication:

• One GP or team is in full control.
• Limited partners just invest money.
• The GP may raise funds from dozens or hundreds of people.

Justin Shore
Yep. JV partners might still snag the short-term rental loophole if they truly put in hours. Once you move toward a large-scale syndication with 30+ passive investors, that’s rarely an option for the LPs. It’s worth clarifying which structure you have.

38:01 – 40:00 | Q&A: Combining Strategies

Thomas Castelli, CPA
We get questions: “Can I do a 1031 from a direct property into a DST and then, if the DST sells, jump into a REIT via an UpREIT?” Theoretically, yes, but it’s complex:

• Sell your direct property, roll into DST via 1031.
• After DST’s eventual sale, you 1031 again into a property that qualifies for an UpREIT transaction.
• Then do a 721 exchange to convert your property interest into REIT shares.

It’s multi-step and requires careful coordination with attorneys and QI (Qualified Intermediary).

Justin Shore
Exactly. The main point: it’s possible to combine different strategies if you know the rules and plan ahead. But each step is specialized, so definitely get a strong advisory team involved.

40:01 – 42:00 | Key Takeaways & Which Strategy Fits Your Goals

Thomas Castelli, CPA
So, in summary, the best approach really depends on:

• Your Desired Level of Control: Do you want to manage or be hands-off?
• Tax Objectives: Is your primary goal offsetting large W-2 income or building passive equity?
• Liquidity Needs: REITs are easiest to exit, DSTs and syndications not so much.
• Time Horizon & Risk Appetite: Short-term rentals can be more lucrative but require more work. Syndications can be stable but you’re in it for the full ride.

Justin Shore
Absolutely. Evaluate your skill set, your time, your capital, and consult with your tax advisor to find the best fit.

42:01 – 43:00 | Closing Remarks & Firm Opportunities

Thomas Castelli, CPA
Well, that’s our overview of major real estate investing strategies and their tax implications. Thanks again to the listener who requested this topic—we hope we did it justice!

Before we sign off:

• We’re hiring: If you’re a CPA or EA and want to work with a real estate-focused firm, email your resume to onboarding@hallcpallc.com and tell us why you’d like to join.
• Now accepting new clients for the 2024 tax year. If you want a proactive real estate CPA, head to www.therealestatecpa.com/podcast to book a discovery call.

Thanks for tuning in, and we’ll see you on the next episode of the TaxSmart REI Podcast!

If you’re interested in reducing taxes through real estate investing, feel free to contact us for more information or consultation.

Disclaimer: This podcast summary and transcript were partly generated by AI and may contain some errors or miss key points from the audio recording.