1031 Exchange Investing
HOW 1031 WORKS
What is a 1031 Exchange?
What is Like-Kind Property?
A 1031 exchange works for many different types of real estate. Eligible like-kind properties include real estate held out for investment or business purposes. The property cannot be your home because that is considered a residence.
For example, you could potentially exchange an apartment for a retail property; or, you could exchange land or a farm for an office building. Finally, you may be eligible to exchange a condo unit for a Delaware Statutory Trust (“DST”) or even a triple net (“NNN”) leased property. If you have specific questions about the kind of property you own and what it would be eligible for in an exchange, send us an email. For specific tax-related information, please consult with your tax professional.
1031 Wealth Advisor Properties
We have created industry-leading due diligence and only recommend investment properties that meet the highest standards suitable to your unique situation. For a list of currently available 1031 exchange properties request a list and we will send it out to you promptly.
Because our due diligence is complete and the properties are available now we can often help an investor close escrow, in some cases, in as little as 2 –3 days. Many of the offerings that are available to our clients are pre-packaged with non-recourse financing in place (35 –75% Loan to Value) and typically have initial net cash flows ranging from 6–8%. We also have exceptional access to sole-ownership net-leased (NNN or NN) property; bank-owned and other opportunistic commercial real estate; and investment offerings structured for a 721 exchange into a Real Estate Investment Trust (UPREIT).
1031 Exchanges and Delaware Statutory Trusts (DSTs)
Since 2000, Delaware Statutory Trusts (DSTs) have been used as a vehicle for capital gains tax deferral, and asset protection. In August 2004, the IRS issued Revised Ruling 2004-86, which clarified how DSTs are classified for federal tax purposes. The ruling stated that a beneficial interest in a DST that owns the real estate will be considered a “direct interest in real estate” and qualify for a 1031 exchange as long as all other requirements have been followed. Investors in a DST own a pro rata interest in the DST and have the right to receive distributions from trust operations. Since this ruling was issued, DSTs have become the most common ownership structure used by investors with $100K to $1M who are investing into jointly-owned investment-grade properties.
Anyone who has attempted a 1031 exchange knows the 45 day ID period can go by quickly, and in most cases you generally don’t want to identify a property without certainty that you can close on it? Selecting a DST can take the headache out of choosing a replacement property during the ID phase. Generally, there are a few, and in many cases several potential DSTs available for investment at any given time. Therefore, investors could review several properties that can be identified immediately. Further, the Sponsors and Issuers of DSTs usually already own the properties by the time they are offered to investors, with financing in place (if any), and all due diligence and legal documentation readily available.
Who holds your funds before you reinvest?
In order to affect a 1031 exchange, the seller must place their transaction funds into a special trust account designated for the purpose of completing an exchange. These accounts are usually established by Accommodators or Intermediaries at banks or other financial institutions. Most importantly, the accounts need to be established before closing the sale of your property, and you must not have constructive receipt of your funds (control). Otherwise, your transaction may not qualify for deferred capital gains.
The Internal Revenue Code requires that the person or entity serving as Qualified Intermediary (“QI”) cannot be someone with whom the exchanger has had a former business or family relationship prior to the transaction. The IRC is clear in the fact that a QI has to be an independent organization whose only contact with the exchanger is to serve as a Qualified Intermediary for them.
1031 Exchange Timelines
When an entity decides to sell a property, they have 180 calendar days from closing to complete their 1031 exchange. The first 45 days are considered the Identification (“ID”) Period. The seller must identify and designate in writing the properties they wish to exchange into by midnight of the 45th calendar day after the close of escrow on the relinquished property.
The seller may designate a group of properties with a combined value that does not exceed 200% of the value of their sale, or they may designate up to three properties. Optionally, an investor may identify any number of potential replacement properties, regardless of their aggregate market value, if the investor acquires 95% of the aggregate market value of all the properties identified using the 95% Rule. For more information regarding identification rules please email us with your questions.
1031 Exchanges and Net-Leased Properties
Many real estate investors are choosing to complete their exchanges by trading into a single-tenant, triple net-leased (NNN) property at stated lease returns and terms with an investment-grade tenant. This may be an appropriate option for investors looking for minimal management responsibilities or interactions with the building. With the popularity of these investment property types, the valuations have increased dramatically in recent years. Thus, finding attractive investments have been increasingly difficult. What’s more, lease terms are becoming more and more favorable to tenants.
Can I 1031 into a Real Estate Investment Trust (REIT)?
One of the most common questions we receive from investors looking for passive income when approaching retirement is: “may I complete a 1031 exchange into a REIT”. Unfortunately, the short answer is “not initially.” Unless a REIT is the buyer of your property, there is no direct way of making an exchange for stock exchange traded shares.
That being said, there are ways a 1031 investor can target passive income with a potential conversion to REIT shares. Although not through the initial transaction, some DST sponsors are strategically planning a sale to Public and Private REITs giving their investors the opportunity to convert their equity interest into shares. Although this would become a two-step transaction, this would potentially enable you to achieve a conversion to REIT shares. The second step, or converting your interest into a REIT is called a Section 721 exchange, or UPREIT. An UPREIT is also a tax deferred transaction.
If the DST is structured correctly, investors can effectively defer their capital gains from an individual property into a DST, and ultimately into a REIT. It is important to note that once the shares of the REIT are sold, there would be a taxable event. The tradeoff at this stage is that investors have liquid shares. Thus, an investor can then plan the disposition of shares and pay capital gains over multiple tax years, instead of all at once. This feature can be very helpful for estate planning purposes.
As always, investors should read the investment memorandum or prospectus for any investment offering and consult with tax and legal advisors regarding their specific situation.