If you own appreciated real estate, a closely held business, or a significant investment portfolio in Washington State, you are sitting on unrealized capital gains. At some point — through a sale, a gift, an exchange, or your death — those gains will be addressed. The question is not whether you will deal with them. The question is how.
Over nearly four decades of practicing law and facilitating 1031 exchanges, I have found that most capital gain situations fall into one of four categories. You can recognize the gain and pay the tax. You can defer it. You can offset it. Or, in certain circumstances, you can eliminate it entirely. Each strategy has its place, and the right answer depends on your specific facts — your tax bracket, your time horizon, your estate plan, and your goals for the next generation.
This article walks through each of those four strategies with an eye toward Washington State's current tax environment, where a 7% capital gains tax (with graduated rates on larger gains), a new 9.9% income tax taking effect in 2028, and a state estate tax with rates up to 20% all factor into the analysis. This is general information, not legal advice — every situation is different, and the right combination of tools requires careful analysis with qualified counsel.
Strategy One: Recognize the Gain
Sometimes the best strategy is to sell the asset, pay the tax, and move on. That may sound counterintuitive in an article about capital gains planning, but recognition is a legitimate strategy when the economics support it.
Consider a Washington investor — a married couple with $400,000 in combined W-2 and investment income — who purchased a rental property for $400,000 fifteen years ago. After depreciation, the adjusted basis is roughly $250,000. The property is now worth $900,000. That is a $650,000 gain. At current federal long-term capital gains rates (20% for high earners), plus the 3.8% Net Investment Income Tax (NIIT),* plus Washington's 7% capital gains tax, the combined tax burden could approach 30% or more — roughly $195,000 or higher on the gain. *The 3.8% NIIT under IRC § 1411 applies to net investment income for taxpayers whose modified adjusted gross income exceeds $250,000 (married filing jointly) or $200,000 (single filers). Not every capital gain transaction triggers the NIIT — it depends on the taxpayer's overall income level for the year. Your tax advisor can help you determine whether it applies to your situation.
So why would anyone choose to recognize that gain? Several reasons. First, if you believe tax rates are going up — and the current trajectory in Washington suggests they will — locking in today's rates could be the less expensive option over time. Second, if the asset is underperforming or concentrated, paying the tax frees your capital to diversify into better-returning or more liquid investments. Third, if the cost of deferral (the obligation to acquire replacement property, ongoing management of property you may not want) exceeds the tax savings, recognition may actually be the more efficient path.
The key is to run the numbers honestly. I have seen clients spend $50,000 in exchange costs and acquire replacement property they did not really want, only to defer $60,000 in taxes. The math did not justify the deferral. A candid analysis of the true cost of each alternative — not just the tax line — is essential.
Strategy Two: Defer the Gain
Deferral is the most commonly discussed capital gains strategy, and for good reason. When you defer a gain, you keep the full pre-tax amount working for you. Compounding on the gross amount rather than the after-tax amount can produce significantly greater wealth over time.
The most well-known deferral mechanism for real estate investors is the 1031 exchange under Internal Revenue Code § 1031. In a properly structured exchange, you sell your relinquished property, have the proceeds held by a qualified intermediary, and acquire like-kind replacement property within strict statutory timelines — 45 days to identify and 180 days to close. The gain and the tax basis carry over to the replacement property. No federal capital gains tax is due at the time of the exchange. Because the gain is deferred, it also stays outside Washington's capital gains tax calculation.
The 1031 exchange is powerful, but it is not free. You must acquire replacement property of equal or greater value and equal or greater debt. The identification rules are strict. You cannot touch the proceeds during the exchange period. And you are committing to continued ownership of investment real estate — which may or may not align with your long-term objectives. For investors who want to stay in real estate and are comfortable acquiring replacement property, a 1031 exchange is often the best tool available. I have been facilitating 1031 exchanges since 1990, and through Olympic Exchange Accommodators — which I founded in 2003 — I have facilitated more than 1,000 exchanges. That experience has shown me firsthand how effective this tool can be when used in the right situation.
Beyond 1031 exchanges, there are other deferral mechanisms worth understanding. Installment sales under IRC § 453 allow you to spread gain recognition over the payment period, reducing the tax impact in any single year. Opportunity Zone investments under IRC § 1400Z-2 can defer gains invested within 180 days, though the original deferral deadlines for basis step-up have largely passed. And for business owners, certain corporate restructuring transactions can defer gain on the transfer of appreciated assets to a new entity.
Strategy Three: Offset the Gain
Offsetting means using losses, deductions, or credits to reduce the taxable gain. This is not about avoiding the sale — it is about reducing the net tax impact when you do sell.
Capital Loss Harvesting
The most straightforward offset is capital loss harvesting. If you hold investments with unrealized losses, selling those positions in the same tax year as your gain can offset dollar-for-dollar against long-term gains. If your losses exceed your gains, you can deduct up to $3,000 against ordinary income and carry the remainder forward. Strategic timing of loss harvesting — particularly in volatile markets — can create meaningful offsets.
Charitable Remainder Trusts
Charitable giving offers another powerful offset. A gift of appreciated property to a qualified charity avoids capital gains tax entirely on the donated amount and provides an income tax deduction for the fair market value (subject to AGI limitations). For larger gifts, a charitable remainder trust (CRT) can provide particularly compelling economics: you transfer appreciated property to the trust, the trust sells it without triggering immediate gain, reinvests the full proceeds, and pays you an income stream for life or a term of years. When the trust terminates, the remainder passes to your designated charity. The CRT is not a tax-free transaction — you pay income tax on the distributions as they come out — but the deferral and the upfront charitable deduction can significantly improve the overall economics compared to a straight sale.
Donor-Advised Funds and the CRUT-DAF Combination
Donor-advised funds (DAFs) offer a simpler alternative for clients who want the charitable deduction now but prefer to make their philanthropic decisions over time. You contribute appreciated stock or other assets to the DAF, receive an immediate deduction, and the DAF sells the assets without capital gains tax. You then recommend grants from the fund to charities of your choosing on your own timeline.
What many clients do not realize is that a DAF and a charitable remainder trust can work together. If you already have a donor-advised fund — or plan to establish one — you can create a charitable remainder unitrust (CRUT) and name your DAF as the charitable remainder beneficiary. This gives you the income stream from the CRUT during your lifetime, and when the trust terminates, the remainder flows into your DAF rather than directly to a single charity. You retain the flexibility to recommend grants from the DAF to multiple charities over time, rather than locking in the charitable beneficiary at the time the trust is created. It is a powerful combination that provides both current income and long-term philanthropic control.
Strategy Four: Eliminate the Gain
Elimination means the gain permanently disappears — no tax is ever paid on it. This is the most powerful strategy, but it typically requires either death, specific charitable structures, or the use of exclusions built into the tax code.
The most significant elimination tool for most families is the basis step-up at death under IRC § 1014. When you die owning appreciated property, your heirs receive the property with a tax basis equal to its fair market value at the date of death. All of the unrealized gain accumulated during your lifetime vanishes. For a long-term investor whose portfolio has grown from $1 million to $5 million, that is $4 million in gain that was never taxed and never will be.
This is why "sell or hold until death" is one of the most important questions in estate planning. If a client is in their seventies and holds a $2 million property with a $300,000 basis, the step-up at death eliminates $1.7 million in capital gains tax — potentially $500,000 or more in combined federal and state taxes. That is a powerful incentive to hold. But it must be weighed against estate tax exposure: if the property pushes the estate above Washington's $3 million exemption (or the federal exemption), the estate tax cost of holding may offset the capital gains savings. This is exactly the kind of trade-off analysis that requires careful modeling with your attorney and tax advisor.
For business owners, IRC § 1202 provides another potential elimination. Qualified Small Business Stock (QSBS) — stock in a C corporation with less than $50 million in assets at the time the stock was issued — can qualify for exclusion of up to $10 million or ten times your basis in gain, whichever is greater. If the stock has been held for at least five years and the business meets the requirements, the gain on sale may be entirely excluded from federal income tax. Washington's capital gains tax currently does not provide a parallel exclusion, so state tax may still apply, but the federal savings alone can be transformative.
The primary residence exclusion under IRC § 121 is another elimination tool. If you have owned and used your home as your principal residence for at least two of the five years before the sale, you can exclude up to $250,000 in gain ($500,000 for married couples filing jointly). For homeowners in Pierce County and the broader Puget Sound region, where values have appreciated significantly, this exclusion can shelter a substantial portion of the gain on a home sale.
The Real Decision: Which Strategy, and When
In practice, the best approach is rarely a single strategy. Most clients benefit from a combination. A real estate investor might use a 1031 exchange to defer gains on investment properties, hold a legacy property for the basis step-up at death, donate appreciated stock to a donor-advised fund to offset gains in a high-income year, and recognize gains on underperforming assets when rates are favorable.
The Washington-specific layer adds complexity. The 7% capital gains tax, the incoming 9.9% income tax, and the state estate tax all interact. A strategy that minimizes federal taxes might increase Washington exposure, and vice versa. The entity structure through which you hold assets matters — direct real estate sales are exempt from Washington's capital gains tax, but sales of interests in entities holding real estate may not be. The timing of transactions relative to the 2028 income tax effective date creates a window for planning that will not last forever.
This is the kind of analysis I do every day — both as an attorney helping clients structure their estate plans and business transactions, and as a qualified intermediary facilitating 1031 exchanges through Olympic Exchange Accommodators. The intersection of those two perspectives is where the most valuable planning happens. If you are holding appreciated assets and wondering which path makes sense for your situation, I would welcome the conversation.
