1031 Exchange Investing
Strategic real estate investors should be knowledgeable about a variety of interrelated issues. They should be aware of the range of options available when it comes to ways to invest in different kinds of real estate, should know how to evaluate potential tenants, assets, and leases, and should stay apprised of macroeconomic trends and important tax and legislative issues.
Here we present educational articles on these different kinds of investing principles.
Frequently Asked Questions
What are the advantages of a 1031 exchange?
The main advantage of 1031 exchanges is that it allows real estate investors to reinvest proceeds from the sale of property held for the purpose of business or investment without owing 20% to 35% of one's capital gain in taxes.
Does a 1031 exchange eliminate capital gains tax?
No. With a 1031 exchange, since you do not ever personally take hold of the proceeds of the sale of your relinquished property, there is no capital gain. Accordingly, capital gains taxes are deferred by a 1031 exchange. If later you sell your replacement properties, the capital gain you realize is calculated in terms of your original relinquished property's basis.
You can, however, continue to defer the recognition of your capital gains using 1031 exchanges until you are ready to pass your investment property on to your heirs. When your beneficiaries inherit your property, its tax basis steps up to the current market value.
What is a DST?
The Delaware Statutory Trust (DST) is structured similarly to a TIC in that it provides a fractional ownership of interests in real estate based on the equity placed by investors. It is also structured for investors to use a 1031, 1033, or 721 exchange.
However, unlike a TIC, owners do not directly hold the title to the property. The owners hold a title to the real estate through a beneficial ownership of the trust. This makes the structure completely passive where investors have no responsibility to vote on any decisions. The trust and managers make decisions on behalf of the investors.
What are the key benefits of a DST?
The main benefits of DSTs as they are used in real estate investing are that (1) you can acquire a fractional interest in several properties held by a DST to complete your 1031 exchange, (2) when a DST is used to complete a 1031 exchange, the investor has no management responsibilities for the properties held by the DST, and (3) DSTs can provide considerably higher cash flow (starting around 5-6%) than is often provided via sole ownership of a rental property.
Is 1031 exchange only for investment property?
No, a 1031 exchange is for both investment property and property held for productive use in trade or business. In order to defer capital gains tax on the sale of property, both the initial property to be sold and the property to be acquired must be either investment or business property.
Do REITs qualify for 1031 exchanges?
No, a REIT does not qualify as part of a 1031 exchange. Investors cannot exchange their property and exit into a REIT through the 1031 process.
However, there is a process through an investor can eventually exit into a REIT. It is a two-step process that begins with a 1031 exchange into a Delaware Statutory Trust (DST). A DST can qualify as a like-kind property. Additionally, certain sponsors form DST portfolios with strategically planned sales to a REIT (a 721 or UPREIT exchange). While this process is more complicated and involves more steps, it is currently the only way to relinquish a property and (eventually) exit into a REIT.
Can a 1031 exchange be used for stocks?
No. Stocks and certain other properties (bonds, inventory, notes, partnership interests, certificates of trust) are all specifically excluded from 1031 exchange. To qualify for a 1031 exchange, property must be held for investment or business purposes.
Can you acquire multiple properties in a 1031 exchange?
Yes, but how many properties you acquire depends on which of the 1031 property identification rules you use to complete your exchange. Depending on the rule you use, you can acquire 3 properties, as many properties as you like as long as their total value does not exceed 200% of the relinquished property’s total value, or as many properties as you like, regardless of their value, as long as you ultimately acquires 95% of the total market value of all properties identified.
- Investment Structures
- Tax and Legislative Issues
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