A Review on Tax Mitigation Strategies

After all, the U.S. tax code is over 6,000 pages long, and within those pages are countless opportunities for those who understand the system. But before diving into any tax-saving strategy, it's crucial to know precisely what you're getting into.

The Risks of Overcomplicated Tax Schemes

There’s an entire industry built around tax mitigation strategies—some are legitimate, while others are, well, questionable at best.

These strategies often target individuals looking to minimize the tax burden from selling a business, practice, or real estate. And let’s be honest—who wouldn’t want to keep more of their hard-earned money?

The Most Prominent Tax Deferral Strategy: The 401K

On the surface, it looks like a win. Contributions reduce your taxable income today, and growth inside the account is tax-deferred. For W-2 earners especially, it feels like a no-brainer. But what happens when it’s time to retire?

All withdrawals from a traditional 401(k) are taxed as ordinary income, not at the lower capital gains rate. And if you’ve accumulated significant savings, those withdrawals can push you into a higher tax bracket in retirement. Plus, required minimum distributions (RMDs) starting at age 73 can force you to withdraw more than you need, further increasing your taxable income.

Here’s the irony: the 401(k) is marketed as a tax-saving tool, but it may actually defer taxes to a time when you have fewer deductions and potentially higher rates. Not to mention, most 401(k)s limit your investment options and charge hidden fees that quietly erode your returns over time. And you can’t start receiving distributions until age 59 ½, placing a limit on when you can retire if you have been largely investing your money through the 401(k).

The 1031 Exchange is Not for Everyone

One of the most conventional and well-documented methods is the 1031 exchange. This provision, which has been around since 1921, allows real estate investors to defer capital gains taxes by rolling the proceeds of one property sale into another. 

The issue with a 1031 exchange is that in today’s high-interest rate environment, finding a suitable property to exchange within the strict time constraints of the 1031 rules can be incredibly challenging.

If you can’t find the right property in time, you could be forced into a bad deal—or worse, pay the taxes you were trying to defer in the first place.

The DSTs: Delaware vs. Deferred Sales Trusts

Beyond the 1031 exchange, there are two currently popular alternatives:

1. Delaware Statutory Trusts (DSTs) – These allow investors to sell real estate and reinvest the proceeds in a passive real estate portfolio, often managed by large firms.
2. Deferred Sales Trusts (DSTs) – Not to be confused with the Delaware version, this strategy structures the sale as an installment sale, deferring taxes over time.

Both of these options operate on one fundamental principle: deferral, not elimination. That means, at some point, the tax bill will come due. And here's the real kicker—tax rates are not likely to go down.

Historically, the highest federal capital gains tax rate has fluctuated between 15% and 35%. As of 2024, the long-term capital gains tax is capped at 20%, but many experts predict it could increase as the government seeks new revenue sources.

The Hidden Costs of Tax Deferral: Control and Fees

Let’s talk about control. When you put your assets into a DST, you’re handing the reins to someone else. Unlike owning your business or rental property—where you dictate terms, pricing, and management—you now rely on a third party. And those third parties aren’t doing this for free.

Most DST sponsors charge substantial fees, often eating into your expected return. If a DST promises an 8-10% return, by the time fees and expenses are factored in, your real return could be significantly lower.

And given the current downturn in commercial real estate values—office vacancies are at a 30-year high in some markets—future returns may not be as rosy as projected.

The Illusion of Tax Deferral

Here’s the real question: Are you better off deferring taxes, or should you just pay the bill and reinvest on your own terms?

Many investors assume deferring taxes is always a win, but let’s do some simple math. If you defer a $1 million capital gain today at a 20% tax rate, you save $200,000 in the short term.

But if that deferred gain grows and tax rates increase to 25% or more, your eventual tax bill could be much larger than if you had just paid it upfront.

A Smarter Alternative: Take Control of Your Capital

Instead of getting locked into complex structures with uncertain returns, many investors find that maintaining liquidity and control over their capital is the best long-term strategy.

By selling an asset, paying the tax, and reinvesting in opportunities you control—whether it’s private lending, value-add real estate, or alternative investments—you position yourself for greater flexibility and potentially higher returns.

Final Thought: Caveat Emptor

At the end of the day, tax mitigation strategies should be a tool, not a trap. If a tax scheme sounds too good to be true, it probably is.

The more complex and restrictive the structure, the harder it is to unwind. Many investors who buy into these strategies later realize they’ve traded tax savings for loss of control, high fees, and lower liquidity.

So before you chase the promise of tax deferral, ask yourself: Would I rather own my financial future or hand it over to someone else?

Real financial freedom isn’t about avoiding taxes—it’s about knowing how to make your money work for you on your terms.