DSCR Loan Portfolio Exit Strategy: When to Sell, Refinance, 1031 Exchange, or Convert to a DST

Building a DSCR-financed portfolio is the easy part. The decisions that determine whether you actually create wealth — or give half of it to the IRS — happen on the exit.

Most investors default to one of two extremes: hold everything forever (and die asset-rich, cash-poor) or sell reactively when a tenant trashes the unit (and eat a six-figure tax bill). Neither is a strategy. This guide covers the four primary exit paths for DSCR portfolios, the math behind each decision, and the timing triggers that signal when it's time to move.

The Four Exit Paths

Exit Path 1: Outright Sale

The Tax Math Most Investors Underestimate

Selling a DSCR-financed property triggers two separate tax events:

1. Capital gains tax on the profit above your adjusted basis. 2. Depreciation recapture taxed at 25% (Section 1250) on all depreciation claimed or allowed to be claimed — even if you didn't take the deduction.

Worked example:

• Purchase price: $350,000 (2022)
• Improvements: $20,000
• Cost basis: $370,000
• Land value: $70,000
• Depreciable basis: $300,000
• Annual depreciation: $300,000 ÷ 27.5 = $10,909/year
• Cumulative depreciation (4 years): $43,636
• Adjusted basis: $370,000 − $43,636 = $326,364
• Sale price: $450,000
• Selling costs (6% agent + 1% closing): $31,500
• Net proceeds: $418,500
• Total gain: $418,500 − $326,364 = $92,136

Tax breakdown:

• Depreciation recapture: $43,636 × 25% = $10,909
• Long-term capital gain: ($92,136 − $43,636) × 20% = $9,700 (at the 20% bracket; 15% if your taxable income is under $533,400 for single filers in 2026)
• Net Investment Income Tax (NIIT): $92,136 × 3.8% = $3,501 (applies if MAGI exceeds $200,000 single / $250,000 married)
• State tax: varies ($0 in FL/TX/NV; up to $9,214 in CA at 10% on gains)

Total federal tax: ~$24,110 on a $450,000 sale with $92,136 in gain. That's 26.2% of your gain, or 5.8% of the gross sale price.

When Outright Sale Makes Sense

• You're exiting real estate entirely and redeploying into non-real-estate assets
• The property has significant deferred maintenance that would cost more than the tax bill to address
• You're in a low-income year (possibly retired, between jobs) and your capital gains rate drops to 0% or 15%
• The property is in a declining market and further holding increases loss risk
• You're over 65 and want simplicity over tax optimization

Timing the Sale for Tax Efficiency

Sell in January of a low-income year rather than December of a high-income year. The difference between the 15% and 20% long-term capital gains brackets can be $4,000–$8,000 on a single property sale.

For 2026, the 15% rate applies to taxable income up to $533,400 (single) or $600,050 (married filing jointly). Above those thresholds, the rate jumps to 20%, plus the 3.8% NIIT.

Exit Path 2: Cash-Out Refinance

Refinancing isn't technically an "exit" — you keep the asset — but it's the most tax-efficient way to extract equity. Debt proceeds aren't taxable income.

DSCR Cash-Out Refinance Parameters (2026)

Cash-Out Refinance: Worked Example

• Current property value: $450,000 (appraised)
• Existing loan balance: $262,500 (original $280,000 at 7.75%, 3 years in)
• Maximum new loan (75% LTV): $337,500
• Cash out: $337,500 − $262,500 = $75,000 (minus closing costs of ~$8,000–$12,000)
• Net cash extracted: ~$63,000–$67,000
• Tax on extraction: $0

The catch: your monthly payment increases. At 7.50% on $337,500, P&I is $2,360/month vs. $2,014 on the old $262,500 balance. Your DSCR drops from 1.44 to 1.13 (assuming $3,200 rent and $500 in T&I). If the lender requires 1.20, you won't qualify for the full 75% LTV. You'd need to take a smaller cash-out or demonstrate higher rent.

The Prepayment Penalty Trap

Most DSCR loans carry prepayment penalties structured as a stepdown:

• 5-4-3-2-1: 5% of the loan balance in year 1, 4% in year 2, etc.
• 3-2-1: 3% in year 1, 2% in year 2, 1% in year 3, then free.

On a $280,000 balance, a 3% prepayment penalty is $8,400. A 1% penalty is $2,800. Factor this into your refinance timing.

Strategy: If you're 11 months into a 3-2-1 penalty, wait one month. The penalty drops from 3% ($8,400) to 2% ($5,600). That one month of patience saves $2,800.

Many investors negotiate the prepayment penalty structure at origination. A 3-2-1 costs 0.125–0.25% less in rate than a no-penalty loan. If you're confident in a 3+ year hold, take the penalty and the better rate.

Serial Refinance Strategy (Velocity Banking)

Experienced DSCR investors use a serial refinance approach:

1. Buy at $350,000 with $87,500 down (75% LTV)
2. Renovate for $30,000, increasing value to $450,000
3. Cash-out refi at 75% LTV = $337,500 loan → extract $75,000
4. Use the $75,000 as down payment on property #2
5. Repeat

Each cycle deploys the same capital into a new asset while retaining the previous one. After 3 cycles, you control $1.35M in property with the original $87,500 plus renovation capital. The risk: you're leveraged at 75% across the portfolio, leaving thin equity cushions if values decline 10–15%.

Exit Path 3: 1031 Exchange

Section 1031 of the Internal Revenue Code allows you to defer capital gains and depreciation recapture taxes by exchanging into a "like-kind" replacement property. For real estate, "like-kind" is broad — a single-family rental can be exchanged into an apartment building, commercial property, or vacant land held for investment.

1031 Exchange Timeline (Non-Negotiable)

These deadlines are statutory. There are no extensions. The IRS denied extensions even during COVID (though there was a brief relief period in 2020 for exchanges in progress). If day 45 falls on a Sunday, your deadline is still that Sunday.

The Three Identification Rules

You must identify replacement properties by day 45 using one of three rules:

1. Three-Property Rule: Identify up to 3 properties of any value.
2. 200% Rule: Identify any number of properties, but their total fair market value cannot exceed 200% of the relinquished property's sale price.
3. 95% Rule: Identify any number of properties, but you must close on at least 95% of the total identified value. (This is nearly impossible to satisfy in practice.)

Most investors use the Three-Property Rule. Identify your top choice, a backup, and a second backup. If your top choice falls through, you have alternatives without busting the exchange.

1031 With DSCR Loans: Specific Complications

Boot risk from debt reduction: In a 1031 exchange, you must replace both the equity and the debt. If you sell a property with a $262,500 loan and buy a replacement with a $200,000 loan, the $62,500 difference is "mortgage boot" — taxable as if you received cash.

DSCR loan qualification on the replacement: You're under a 180-day clock. DSCR loan closings average 21–35 days, but appraisal delays, title issues, or insurance holdups can stretch this to 45–60 days. Start your lender relationship and get pre-qualified before listing the relinquished property.

Prepayment penalties on the relinquished property's DSCR loan: The penalty is a selling cost, not boot. It reduces your net proceeds but doesn't create a taxable event. However, it does reduce the cash available for the replacement property's down payment.

1031 Exchange Cost

• Qualified Intermediary fee: $750–$1,500
• Legal review of exchange documents: $500–$2,000
• Additional title/escrow fees for exchange closing: $300–$600
• Total: $1,550–$4,100

Against a potential $24,000+ tax deferral (per the earlier example), the ROI on a 1031 exchange is enormous — if you can execute within the timeline.

Reverse 1031 Exchange

If you find the replacement property before selling the relinquished property, a reverse exchange allows you to acquire the replacement first. The QI (through an Exchange Accommodation Titleholder, or EAT) takes title to the replacement property, you sell the relinquished property, and the exchange completes.

Cost: $5,000–$15,000 (significantly more expensive due to the EAT structure). Useful when you find a deal you can't pass up but haven't sold yet.

Exit Path 4: Delaware Statutory Trust (DST) Conversion

A DST allows you to 1031 exchange into a fractional interest in an institutionally managed property (or portfolio of properties). You become a passive beneficiary — no management responsibilities, no tenant calls, no maintenance decisions.

How DSTs Work

1. A DST sponsor (typically a large real estate firm) acquires a property — say, a $50M apartment complex.
2. The sponsor divides beneficial interests into fractional shares, typically $100,000–$250,000 minimum.
3. Investors 1031 exchange into DST interests, deferring their capital gains.
4. The DST distributes rental income (typically 4–6% annually) to beneficial owners.
5. After 5–10 years, the sponsor sells the property. Investors receive their share of proceeds and can 1031 exchange again — or take the cash and pay taxes.

DST Advantages for DSCR Portfolio Owners

• Eliminates management burden. You're done being a landlord.
• Solves the 45-day identification problem. DST interests are readily available and can be identified quickly. No house hunting under pressure.
• Diversification. Exchange a $400,000 single-family rental into interests in a $50M apartment complex, a $30M industrial warehouse, and a $20M medical office building.
• Estate planning. DST interests receive a stepped-up basis at death under current law. Your heirs inherit the interest at current fair market value, eliminating all deferred capital gains and depreciation recapture.

DST Risks and Limitations

• Illiquidity. There's no secondary market for DST interests. You're locked in for the hold period (typically 5–10 years).
• No control. You can't vote on property decisions, choose tenants, or authorize improvements. The sponsor makes all decisions.
• Fee drag. DST sponsors charge acquisition fees (1–3%), asset management fees (1–2% annually), disposition fees (1–3%), and financing coordination fees. Total fees over the life of the investment can consume 10–15% of returns.
• IRS scrutiny. The IRS has increased audit frequency on DST exchanges. Ensure your DST sponsor has a clean track record and the offering is structured as a true 1031-eligible interest, not a security disguised as real estate.
• Debt mismatch. DSTs carry non-recourse debt. If your relinquished property had $262,500 in debt, the DST's allocated debt to your interest must equal or exceed that amount to avoid mortgage boot.

DST Suitability Checklist

Portfolio Liquidation Sequencing

If you're exiting a multi-property DSCR portfolio, the order in which you sell matters.

Strategy: Sell Losers First, Exchange Winners

Properties with minimal gain or actual losses should be sold outright — no need to waste a 1031 exchange on a low-gain sale. The capital loss offsets gains from other investments. Properties with large embedded gains (from appreciation + cumulative depreciation) should be 1031 exchanged or DST-converted.

Example 5-property portfolio:

Total portfolio value: $1,570,000. Gains subject to 1031 deferral: $375,000. Gains subject to tax: $90,000. Estimated tax savings from 1031/DST: $80,000–$95,000.

Timing Across Tax Years

If selling multiple properties outright, spread sales across tax years to stay within lower capital gains brackets. Selling properties A, C, and E in one year creates $90,000 in gains — potentially pushing you from the 15% to 20% capital gains bracket. Selling A and C in December 2026 and E in January 2027 splits the gain across two tax years.

Refinance vs. Sell vs. Exchange: The Decision Tree

Start here: Do you need cash?

• No → Hold. There's no reason to exit a performing DSCR asset that cash flows.
• Yes, but want to keep the asset → Cash-out refinance. Tax-free liquidity.
• Yes, and willing to dispose → Continue below.

Is the gain significant (>$50,000)?

• No → Sell outright. The 1031 exchange costs ($1,500–$4,000) and complexity aren't worth it for small gains.
• Yes → Continue below.

Do you want to stay active in real estate?

• Yes → 1031 exchange into a larger or better property.
• No → 1031 into a DST for passive income, or sell outright if you're done with real estate.

Can you identify a replacement property within 45 days?

• Yes → Standard 1031 exchange.
• No, but I want to buy first → Reverse 1031 exchange (budget $5,000–$15,000 extra).
• No, and I don't want the deadline pressure → 1031 into a DST (always available, no property search needed).

The Stepped-Up Basis End Game

For investors over 60 with large embedded gains, the most tax-efficient exit strategy may be no exit at all. Under current law (IRC §1014), heirs receive a stepped-up cost basis equal to the fair market value at the date of death.

Example: You hold a property with a $160,000 adjusted basis and $350,000 fair market value. If you sell, you owe tax on $190,000 in gains (~$49,000 in federal tax). If you hold until death, your heir inherits at a $350,000 basis and can sell for $350,000 with $0 in tax. All deferred 1031 gains and depreciation recapture — eliminated.

This is the strongest argument for serial 1031 exchanges: defer, defer, defer, and let the step-up eliminate the accumulated tax liability at death. Whether this provision survives future tax legislation is uncertain — the Biden administration proposed eliminating the stepped-up basis in 2021, and similar proposals resurface periodically.

Bottom Line

Your DSCR portfolio exit strategy should be planned at acquisition, not improvised at disposition. Know your prepayment penalty schedule, track your adjusted basis annually, maintain a relationship with a Qualified Intermediary before you need one, and sequence your exits to minimize lifetime tax liability. The properties you bought with a DSCR loan don't care how you exit — but the IRS does.