Part I · Asset Classes · No. 10

Trophy real estate

A $50 million townhouse, a Palm Beach oceanfront, an Aspen ranch. Real property remains the most tax-favored luxury asset class — §1031 exchange survived the 2017 amendment, the §121 principal-residence exclusion shelters substantial gain, and the §1014 step-up extinguishes lifetime appreciation.

The asset class in tax terms

Real property held for personal use is a non-depreciable capital asset under §1221. Real property held for productive use in a trade or business or for investment is §1231 property — depreciable, eligible for §1031 like-kind treatment, and subject to §1250 recapture on disposition. A primary residence may qualify for the §121 exclusion of up to $250,000 ($500,000 for married couples) of gain on sale.

Acquisition

State and local transfer and recording taxes are material:

• New York "mansion tax" — 1% on residential transfers of $1 million or more statewide, graduated in New York City from 1% up to 3.9% (for $25 million and above), paid by the buyer under Tax Law §1402-a.
• State and local transfer tax — New York State 0.4% (0.65% on NYC residential transfers of $3 million or more), plus NYC real property transfer tax; Florida documentary stamp tax 0.70% (0.60% on single-family residences in Miami-Dade); California county tax of $1.10 per $1,000 plus city taxes that can be far higher on high-value sales (e.g. Los Angeles Measure ULA); none in Texas.
• Recording fees.
• Mortgage recording tax in certain states.

Foreign-buyer transfer taxes apply in select jurisdictions: British Columbia and Ontario impose foreign-buyer taxes; New York City has considered but not enacted a comparable measure.

Holding and operation

Annual costs:

• Property tax. The dominant ongoing cost, varying widely by jurisdiction. California Proposition 13 caps the general levy at 1% of assessed value and limits annual assessment increases to 2% until a change in ownership or new construction. Texas has no income tax but materially higher property tax.
• Mortgage interest. Deductible on acquisition indebtedness up to $750,000 on a principal residence and one second home combined — made permanent by the One Big Beautiful Bill Act; debt incurred before December 16, 2017 keeps the $1 million limit.
• SALT cap. Under §164(b)(6) as amended by the One Big Beautiful Bill Act, the cap on itemized state-and-local tax deductions is $40,000 for 2025 and $40,400 for 2026 (rising 1% a year through 2029), reduced by 30% of modified AGI above $500,000 ($505,000 for 2026) but not below $10,000, and reverting to $10,000 from 2030. Most trophy-property owners are in the phase-down range.
• Depreciation on rental or investment property under §168: 27.5-year recovery (residential rental) or 39-year recovery (nonresidential).

Income from the asset

Rental income from investment property is real-estate rental, generally passive under §469 absent material participation. Net rental income is subject to §1411 NIIT for high-income taxpayers. Active real-estate professional status under §469(c)(7) permits passive losses to offset ordinary income.

Short-term rentals (Airbnb-style) below the seven-day threshold are not rental activity under Treas. Reg. §1.469-1T(e)(3)(ii)(A) — so the §469(c)(7) and passive-rental rules do not apply to them in the usual way, and losses depend on material participation; self-employment tax applies only where substantial services are provided.

Disposition

Sale of a personal residence: §121 excludes up to $250,000 ($500,000 joint) of gain, subject to two-out-of-five-year ownership and use tests. Gain in excess of the exclusion is long-term capital gain at up to 20% plus 3.8% NIIT plus state.

Sale of investment property: long-term capital gain plus 3.8% NIIT plus state, with §1250 unrecaptured gain taxed at the 25% rate.

§1031 exchange remains available for real property after the 2017 amendment. See like-kind exchanges. Real-property exchanges allow indefinite deferral with eventual §1014 step-up at death — the most tax-favored disposition path for appreciated real estate.

Installment sale under §453 is available; particularly useful for non-dealer real property where the seller is willing to hold paper.

FIRPTA: foreign sellers of U.S. real estate are subject to withholding under §1445 at 15% of gross proceeds, with adjustment to actual liability on filing. Buyers from foreign sellers are liable for the withholding.

Gift and estate

Inclusion at fair market value. Valuation discounts apply for fractional interests; Estate of Bonner v. United States, 84 F.3d 196 (5th Cir. 1996), and later cases allow fractional-interest discounts for tenancy-in-common interests. Family-limited-partnership and LLC discounts are more aggressive but more litigated.

The §2702 special valuation rules constrain GRATs and similar retained-interest structures. The §2036 retained-enjoyment rule has been heavily litigated in family-real-estate-partnership cases; Estate of Strangi, 417 F.3d 468 (5th Cir. 2005), is the leading case.

Charitable contribution of a conservation easement on trophy real estate may qualify for §170(h) deduction. The IRS has pursued syndicated easements aggressively; SECURE 2.0 (2022) disallows deductions for partnership easement contributions exceeding 2.5 times the partners' relevant basis, and Treas. Reg. §1.6011-9 identifies syndicated easements as listed transactions. Non-syndicated traditional easements remain a workable structure. See conservation easements.

Common structures

• Personal ownership. Primary residences typically held personally to preserve §121 exclusion.
• Single-member LLC. Investment property; preserves disregarded-entity character.
• Partnership / LLC. Joint ventures, family ownership, syndications.
• Qualified opportunity fund. Real-estate investment with deferred and partially excluded gain. Gain deferred under the original program is recognized on December 31, 2026; the One Big Beautiful Bill Act made the program permanent with new zone designations and a rolling five-year deferral for investments made from January 1, 2027. See opportunity zones.
• Foreign-buyer structures. Foreign acquirers of U.S. real estate routinely use blocker corporations to manage FIRPTA, estate-tax, and disclosure exposure.
• Dynasty trust. Long-term family holdings sited in South Dakota or Delaware.

Audit and enforcement landscape

Real-estate audit attention focuses on (a) §1031 exchange substance and timing; (b) basis and improvement substantiation; (c) FLP/LLC valuation discounts on estate returns; (d) conservation-easement valuations; and (e) FIRPTA compliance.

Platform reporting on Form 1099-K brings short-term rental income into IRS view, although the One Big Beautiful Bill Act restored the $20,000 / 200-transaction threshold retroactively to 2022 after the $600 threshold was repeatedly delayed. State-level enforcement of short-term rental occupancy taxes has been aggressive in tourist markets (New York City, San Francisco, Honolulu).

Jurisdictional notes

• Florida. Homestead exemption, no state income tax, popular trophy market.
• New York. Mansion tax, state estate tax with low exemption, urban market concentration.
• California. Proposition 13 property-tax cap, high state income tax.
• United Kingdom. SDLT on residential purchases in England and Northern Ireland reaches 19% on the top slice (12% plus the 5% higher-rates surcharge plus the 2% non-resident surcharge, as of 2025-26); a 17% flat rate can apply to dwellings over £500,000 bought by companies.
• Switzerland. Cantonal-level property tax; restrictions on foreign ownership under Lex Koller.
• Italy. IMU annual property tax; rural-property regimes.
• UAE. Limited freehold zones; no property tax in Dubai.

Reviewed October 2026