The Part Nobody Plans For
Most real estate investors plan carefully for:
- Acquisition — price, market, financing
- Depreciation — cost segregation, bonus depreciation, MACRS
- Deductions — operating expenses, interest, management fees
Very few plan for:
- Disposition — how the property will actually be sold
- Entity sale vs. asset sale — which is possible and which is optimal
- Recapture timing — when accelerated depreciation comes back
- Liability runoff — what happens to latent claims after exit
Exit is where structure either pays off or punishes you. And by the time you're at exit, it's too late to fix.
Author's note (Sam Young, EA): I've seen investors execute brilliant acquisition and tax strategies — capturing $100k+ in first-year savings — only to lose a significant portion at exit because the structure wasn't designed for it. Exit optionality is a form of risk management, and it's earned at acquisition, not at sale.
Selling the Entity vs. Selling the Asset
This is one of the most consequential structural decisions in real estate — and most investors don't even know it's a choice until exit.
Selling the Entity (LLC Membership Interests)
Under most state LLC statutes (consistent with ULLCA §502), membership interests in an LLC are transferable personal property. This makes entity-level sales a distinct transaction type with significant advantages:
Advantages:
- Avoids transfer taxes and recording fees (often 1%–2% of sale price)
- Preserves depreciation history for the buyer (IRC §168 schedules continue uninterrupted)
- Simplifies buyer onboarding — contracts, licenses, and permits stay with the entity
- Can be faster and cleaner for commercial transactions
Requirements:
- The entity was properly isolated — one property, no other activities
- No unrelated liabilities exist inside the entity
- Operating agreement supports transfer of membership interests
- Clean books with no commingling
- No hidden environmental, legal, or tax issues
Selling the Asset (Property Deed Transfer)
Advantages:
- Buyer gets a clean start with no inherited liabilities
- Simpler due diligence for the buyer
- Standard process that all parties understand
Disadvantages:
- Transfer taxes and recording fees apply
- Buyer starts fresh depreciation schedule (no carryover)
- More administrative friction
The Structural Catch
Entity sales are often the better economic outcome — saving 1%–2% in transfer taxes and offering buyer advantages that can justify a higher price.
But entity sales are only possible if the entity was clean from the beginning:
| Entity Status | Can You Sell the Entity? | Impact |
|---|---|---|
| Isolated (1 property, no operations) | Yes — clean transfer | Buyer gets a turnkey entity |
| Multiple properties in one LLC | No — can't sell one property via entity | Must sell the asset instead |
| Operations mixed with holdings | No — hidden liability risk | Buyer won't accept entity purchase |
| Sloppy operating agreement | Difficult — legal friction | Deal slows down or falls apart |
| Commingled finances | No — can't prove clean books | Buyer walks or demands discount |
If you reused an entity, selling the entity at exit is essentially impossible. You've eliminated your most valuable exit option before you even listed the property.
Exit Optionality Is Earned Early
You cannot "fix" exit structure at exit. This is a critical point that most investors learn too late.
Courts ignore:
- Retroactive restructuring done before a sale
- Post-incident entity cleanups
- Last-minute property transfers between entities
- Formation of new entities to "clean up" existing ones
Order of operations matters. The entity structure that enables a clean exit must be in place at or before acquisition. Restructuring later is possible but carries tax implications, legal risks, and time constraints that reduce its effectiveness.
This is the same principle that applies to asset protection generally — structure is chronological, not conceptual. The calendar matters more than the entity.
Depreciation Recapture: The Tax Event Most Investors Forget
If you used cost segregation to accelerate depreciation (and you should — it's one of the most powerful strategies available), you need to plan for recapture at exit.
How Recapture Works
When you sell a property, the IRS "recaptures" accelerated depreciation:
- Section 1250 recapture — depreciation on real property taxed at up to 25% (vs. your original deduction at 37%+)
- Section 1245 recapture — depreciation on personal property (5-year, 7-year assets) taxed as ordinary income
The Math
| Scenario | Reclassified Amount | Depreciation Taken | Recapture Tax (25%) | Net Benefit |
|---|---|---|---|---|
| $1M property, 30% reclass, 5-year hold | $240,000 | $240,000 | $60,000 | $180,000 in present-value tax benefit |
| Same property, 2-year hold | $240,000 | $240,000 | $60,000 | ~$80,000 (less time-value compounding) |
| Same property, 1031 exchange | $240,000 | $240,000 | $0 (deferred) | Full benefit preserved |
Strategies to Manage Recapture
1031 Exchange (IRC §1031) — Defer all depreciation recapture by exchanging into a like-kind property. Treasury Regulation §1.1031(a)-1 permits exchanges of real property held for productive use or investment. This is the most powerful recapture management tool and the reason sophisticated investors rarely do outright sales.
Installment Sale (IRC §453) — Spread the gain (and recapture) over multiple years to manage tax bracket impact. Note: IRC §453(i) requires recapture income to be recognized in the year of sale regardless of installment election.
Opportunity Zone Investment (IRC §1400Z-2) — Reinvest gains into qualified opportunity zones for deferral and potential exclusion. Properties held 10+ years in a qualified opportunity fund may permanently exclude post-investment appreciation from taxation.
Hold Until Death (IRC §1014) — Heirs receive a stepped-up basis, eliminating all depreciation recapture. This is the ultimate long-term strategy — decades of accelerated deductions are never recaptured.
The key insight: Recapture is manageable — but only if you planned for it. If entity structure prevents a 1031 exchange (e.g., multiple properties in one entity, mixed activities), your exit options narrow dramatically.
Learn more about whether cost segregation is worth it given your hold period and exit strategy.
The Exit Scenarios Nobody Models
Scenario 1: Clean Exit (Proper Structure)
| Step | Outcome |
|---|---|
| Property in isolated LLC | Entity sale is an option |
| No mixed activities | Buyer accepts entity purchase |
| Clean operating agreement | Transfer of membership interests is straightforward |
| 1031 exchange eligible | Recapture deferred |
| Result | Maximum optionality, best economic outcome |
Scenario 2: Forced Asset Sale (Entity Reuse)
| Step | Outcome |
|---|---|
| Property in shared LLC with 3 others | Can't sell entity (buyer inherits all liabilities) |
| Mixed operations | Additional liability concerns |
| Must sell asset via deed transfer | Transfer taxes apply (1%–2%) |
| 1031 exchange complicated | Must untangle entity first |
| Result | Higher costs, longer timeline, fewer buyers |
Scenario 3: Litigation During Exit (No Structure)
| Step | Outcome |
|---|---|
| Pending lawsuit against the LLC | Buyer walks away |
| All properties in one entity | Entire portfolio frozen during litigation |
| No entity isolation | Can't sell unaffected properties separately |
| Exit delayed indefinitely | Cash flow disrupted, carrying costs compound |
| Result | Forced to settle or accept deep discount |
Liability Runoff: The Risk That Follows You
Even after selling a property, liabilities from the ownership period can surface. Statutes of limitation and repose vary by state, but exposure periods can be extensive:
- Construction defects — discovered years after completion (statutes of repose range from 4–12 years depending on state)
- Environmental contamination — CERCLA (42 U.S.C. §9601 et seq.) imposes strict liability that may not manifest for decades
- Tenant claims — filed after move-out under state landlord-tenant statutes
- Tax audits — IRS has 3+ years to examine returns under IRC §6501(a), extended to 6 years for substantial omissions under §6501(e)
If you sold the asset (deed transfer), these liabilities remain with the original entity (and you, if personally liable).
If you sold the entity (membership interests), these liabilities transfer to the buyer — but only if the operating agreement and purchase agreement were properly drafted.
Proper structure protects you coming and going. Improper structure creates exposure that persists long after you've cashed the check.
Overline's Approach to Exit Planning
Exit flexibility is a form of risk management. We help investors:
- Preserve optionality — structure entities at acquisition for maximum exit flexibility
- Track structural assumptions — monitor when reality drifts from the original plan
- Avoid irreversible decisions — identify entity choices that eliminate future options
- Model exit scenarios early — understand recapture, 1031 eligibility, and entity sale viability before you need them
This integrates with our cost segregation studies, which provide the depreciation schedules and asset inventories that make exit modeling possible.
The Decision Framework
Use this to evaluate your current exit readiness:
Green lights (maximum exit optionality):
- Each property in its own isolated LLC
- Clean operating agreement with defensive provisions
- No mixed activities (operations separate from holdings)
- Cost segregation study with detailed asset-level depreciation schedules
- 1031 exchange strategy identified
Yellow lights (reduced optionality):
- Multiple properties in one entity (can restructure proactively)
- Boilerplate operating agreement (can be updated)
- Some activity mixing (can be separated)
Red lights (exit likely compromised):
- All properties personally held or in one LLC
- Active litigation against the entity
- Commingled finances with no documentation
- Recent restructuring (courts may disregard)
Frequently Asked Questions
Q: I used cost segregation and took bonus depreciation. How does that affect my exit? A: You'll face depreciation recapture when you sell — accelerated depreciation is taxed at up to 25% (Section 1250) or as ordinary income (Section 1245). However, the time value of money from front-loading depreciation almost always outweighs the recapture cost on holds of 3+ years. A 1031 exchange defers recapture entirely. The key is planning for it, not avoiding cost segregation because of it.
Q: Can I do a 1031 exchange if my properties are in one LLC? A: It's complicated. 1031 exchanges require like-kind property exchanges, and selling one property out of a multi-property LLC creates legal and tax complexities. It's significantly cleaner with per-property entities. If you're planning to 1031, restructure proactively — well before the disposition timeline.
Q: Is it too late to fix my entity structure if I'm planning to sell next year? A: Possibly, but it depends on specifics. Restructuring close to a sale can raise questions about substance and timing. Courts and the IRS look unfavorably at last-minute changes. The earlier you address it, the better. If you're 12+ months from sale, there's usually time. If you're 3 months out, the options narrow significantly.
Q: What's the difference in transfer taxes between entity sale and asset sale? A: Transfer taxes vary by state and municipality but typically range from 0.5%–2% of sale price. On a $2M property, that's $10,000–$40,000 in savings from an entity sale. Combined with simplified buyer transition and depreciation history preservation, entity sales often justify the structural investment many times over.
Q: Should exit planning affect my decision about whether to do cost segregation? A: Exit planning should inform your cost segregation strategy, not prevent it. For holds of 3+ years, cost segregation is almost always beneficial regardless of exit method. For shorter holds (under 2 years), the recapture may reduce net benefit — use our free calculator to model your specific scenario. The bigger question is whether your entity structure supports your preferred exit method.
Continue Reading
Explore more guides from our library:
- The #1 Reason Investors Lose Everything — Why structure failure, not bad deals, ends careers
- Cost Segregation Without Structure Is Fake Optimization — Why tax savings alone isn't enough
- The Most Expensive Mistake: Entity Reuse — Why "efficiency" quietly destroys portfolios
- Is Cost Segregation Worth It? — Decision framework including hold period and exit analysis
- 100% Bonus Depreciation: One Big Beautiful Bill Act — How the July 2025 legislation impacts your strategy
Disclaimer: This content is for informational purposes only and does not constitute legal, tax, or financial advice. Exit strategies, entity structuring, and depreciation recapture depend on your specific circumstances, state laws, and tax situation. Consult qualified legal and tax professionals regarding your specific situation.