Real Estate Transactions and Development

Real estate development in Texas offers strong opportunities for growth and profit, but it also presents a complex landscape of federal, state, and local tax issues. Choosing the right entity, structuring ownership appropriately, and taking advantage of available tax incentives can significantly improve after-tax returns.

At Vanguard Legal PLLC, our Houston and Dallas attorneys advise developers, investors, and real estate sponsors on how to structure their projects efficiently from both a legal and tax perspective. Below is an overview of key tax considerations for Texas real estate transactions and development ventures.

1. Federal Income Taxation of Real Estate Development Activities

Ordinary Income vs. Capital Gain

A critical distinction in real estate taxation is between ordinary income and capital gain.

• Dealers or developers—those who buy, subdivide, and sell real property as part of their business—are typically taxed at ordinary income rates on gains from sales.

• Investors—those who hold property for long-term appreciation or rental income—may qualify for long-term capital gains rates (currently lower than ordinary income rates).

Developers should plan carefully to distinguish development property (inventory) from investment property held for appreciation or long-term leasing.

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2. Entity Choice for Real Estate Developers

The choice of entity for holding and developing real estate can have significant tax implications. In Texas, most developers use limited liability companies (LLCs) or limited partnerships (LPs) because both provide liability protection and pass-through taxation.

Comparison: LLC vs. Limited Partnership in Texas

In practice, LLCs are ideal for smaller or closely held development ventures, while limited partnerships are often used for larger projects or multi-investor funds, where a corporate general partner provides liability protection.

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3. Federal and Texas Tax Treatment of LLCs and LPs

For federal income tax purposes, both LLCs and LPs are typically treated as pass-through entities, meaning income and losses flow through to the owners’ individual returns. The entity itself generally pays no federal income tax (unless it elects to be taxed as a corporation).

Under Texas tax law, both LLCs and LPs may be subject to the Texas Franchise Tax, which is a form of gross margin tax rather than an income tax.

• Passive investment entities (those that only hold real estate and do not actively manage it) may qualify for exemption from the franchise tax.

• Active developers typically do not qualify for this exemption and should plan accordingly.

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4. Best Practices for Holding Real Estate for Development

Separate Assets by Function

To minimize liability and manage tax exposure, developers often:

• Use separate LLCs or LPs for each project or property;

• Hold land and improvements in different entities (for example, one for ownership, another for operations); and

• Create joint ventures with investors or landowners through separate entities for each development.

Maintain Dealer vs. Investor Separation

Developers may hold certain properties as investment properties in one entity and development inventory in another to preserve capital gain treatment where possible.

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5. Recommended Tax Elections for Real Estate Developers

Section 754 Election

A Section 754 election allows partnerships and LLCs taxed as partnerships to adjust the basis of their assets when ownership interests are transferred or upon the death of a partner.
This can provide additional depreciation deductions to the new partner and help align tax basis with fair market value.

Section 1031 Like-Kind Exchange

Developers who hold property for investment (not inventory) may use Section 1031 exchanges to defer recognition of gain by reinvesting sale proceeds into similar “like-kind” real property.
Care must be taken—property held for resale or development does not qualify for 1031 treatment.

Section 1237 Safe Harbor

In limited cases, non-dealer investors who subdivide land can avoid being classified as dealers if they meet certain conditions under Section 1237 of the Internal Revenue Code.

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6. Tax Incentives and Credits for Texas Real Estate Developers

Texas offers a number of state and local incentives for real estate investment and development, in addition to federal programs.

Federal Incentives

• Opportunity Zones: Investments in Qualified Opportunity Funds can defer and potentially exclude capital gains.

• Energy Efficiency Credits: Developers of green buildings may qualify for deductions under Sections 45L (residential) and 179D (commercial).

• Low-Income Housing Tax Credits (LIHTC): Available for affordable housing projects meeting federal and state criteria.

• Historic Preservation Credits: Rehabilitation of certified historic buildings can yield a 20% federal tax credit.

Texas and Local Incentives

• Texas Enterprise Zone Program: Refunds state sales and use taxes for qualifying projects that create local jobs.

• Property Tax Abatements: Local governments may reduce or defer property taxes for development projects in targeted areas.

• Tax Increment Reinvestment Zones (TIRZ): Developers may benefit from infrastructure improvements funded by property tax increments.

• Chapter 380/381 Economic Development Agreements: Cities and counties can provide loans or grants to incentivize development.

Our attorneys assist clients in identifying and negotiating these incentives, coordinating with local economic development authorities, and structuring entities to qualify for available benefits.

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7. Federal Tax Strategies for Real Estate Developers

Maximize Depreciation Deductions

• Use cost segregation studies to accelerate depreciation on building components such as electrical, plumbing, and fixtures.

• Take advantage of bonus depreciation and Section 179 expensing where applicable.

Manage Timing of Income and Expenses

• Elect completed contract or percentage-of-completion accounting methods carefully to match income recognition with cash flow.

• Capitalize certain development costs to defer income recognition.

Utilize the Qualified Business Income (QBI) Deduction

Developers operating through pass-through entities may qualify for the 20% Qualified Business Income deduction under Section 199A, though limitations apply depending on income levels and whether the activity qualifies as a “trade or business.”

Consider the Impact of the “One Big Beautiful Bill Act”

The One Big Beautiful Bill Act (OBBBA), enacted in 2025, introduced several updates relevant to real estate developers, including:

• Expanded energy efficiency credits and green building incentives;

• Enhanced rules for Opportunity Zone reinvestment periods; and

• Adjustments to Section 704(c) allocations affecting partnership basis adjustments and depreciation methods.

Developers should review partnership and fund agreements to ensure compliance and optimize these new benefits.

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8. State and Local Tax Planning Tips

• Confirm franchise tax classification early—some real estate entities may qualify for reduced or no Texas franchise tax if properly structured.

• Coordinate with local appraisers to ensure property tax valuations reflect realistic project status (especially during development stages).

• Document related-party transactions between developer entities to withstand scrutiny from tax authorities.

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9. How Vanguard Legal PLLC Can Help

At Vanguard Legal PLLC, we help Texas developers structure their real estate ventures for maximum tax efficiency and legal protection. Our team regularly assists clients with:

• Entity formation and structuring of LLCs, LPs, and joint ventures;

• Drafting partnership and operating agreements tailored for development projects;

• Advising on federal and Texas tax elections and compliance;

• Navigating Opportunity Zone investments;

• Coordinating with tax accountants and economic development agencies; and

• Advising on federal, state, and local incentives and credits.

Our attorneys combine corporate, real estate, and tax expertise to help clients develop property strategically while minimizing tax exposure.