Real Estate / 1031 Exchanges

What is a 1031 Exchange?

Section 1031(a)(1) provides that no gain or loss shall be recognized on the exchange of property held for productive use in a trade, business, or for investment if the property is exchanged solely for property of a like kind that is to be held either for productive use in a trade or business or for investment.

Under § 1031(d), the basis of property acquired in a § 1031 exchange is the same as the basis of the property exchanged, decreased by any money the taxpayer receives and increased by any gain the taxpayer recognizes.

Under § 1031(a)(3) and § 1.1031(k)-1(b) of the Income Tax Regulations, however, the property to be received by a taxpayer in the exchange (replacement property) must be:

1. Identified within 45 days of the transfer of the property relinquished in the exchange (relinquished property)
2. Received by the earlier of 180 days after the transfer of the relinquished property or the due date (including extensions) of the transferor’s tax return for the taxable year in which the relinquished property is transferred.

Why consider a 1031 Exchange?

• Tax Deferral
• Wealth Preservation
• Income Stability
• Estate Planning and Wealth Transfer

What are my potential tax liabilities if I don’t complete a 1031 exchange?

• Long Term Federal Capital Gains – up to 20%
• State Taxes – Up to 14% in some states
• Depreciation Recapture – 25% of utilized depreciation
• Net Investment Tax – 3.8%

What are the steps?

1. Engage a Qualified Intermediary in advance of your property sale.   
2. Sell your existing property. Cash proceeds are held by your Qualified Intermediary.   
3. Identify one or more replacement properties within 45 days of the sale of your relinquished property.
4. Purchase your replacement property within 180 days of the sale of your relinquished property.

What is a DST (Delaware Statutory Trust)?

A Delaware Statutory Trust permits fractional ownership in a single property or portfolio of properties and qualifies as replacement property as part of an investor’s 1031 exchange.

Beneficial ownership of real estate in a DST is considered the direct ownership of real estate, satisfying the like-kind requirement of Section 1031

IRS Revenue Ruling 2004-86 provides guidance on the use of a DST for property ownership in a 1031 exchange. 

Benefits of a DST:

Approved accredited investors can utilize the DST to defer taxes while repositioning and diversifying their real estate holdings across geographies, asset classes and property types.

• Institutional grade real estate
• Low investment minimums
• Portfolio Diversification
• Rental Income
• Passive ownership
• Quick closings

Summary Risk Factors:

An investment in the Interests of any DST involves significant risk and is suitable only for investors who have adequate financial means, desire a relatively long-term investment and who will not need immediate liquidity for their investment and can afford to lose their entire investment. Investors must read and carefully consider the discussion set forth in the section of each Memorandum captioned “Risk Factors.” The risks involved with an investment in the DSTs include, but are not limited to:

• The Interests may be sold only to accredited investors, which, for natural persons, are investors who meet certain minimum annual income or net worth thresholds.
• The Interests are being offered in reliance on an exemption from the registration requirements of the Securities Act of 1933, as amended, and are not required to comply with specific disclosure requirements that apply to registration under the Securities Act of 1933, as amended.
• The Securities and Exchange Commission has not passed upon the merits of or given its approval to the Interests, the terms of the offerings, or the accuracy or completeness of any offering materials.
• The Interests are subject to legal restrictions on transfer and resale and investors should not assume they will be able to resell their Interests.
• Investing in Interests involves risk, and investors should be able to bear the loss of their investment.
• Investors will have limited control over the Trust.
• The Trustees will have limited duties to Investors and limited authority.
• There are inherent risks with real estate investments.
• There are economic risks associated with a fluctuating U.S. and world economy. There are also risks of investor confidence related to public health concerns.
• The Trust may depend on a Master Tenant for revenue, and the Master Tenant will depend on the residents/tenants under the residential/tenant  leases, and any default by the Master Tenant or the Residents/Tenants will adversely affect the Trust’s operations
• The costs of complying with environmental laws and other governmental laws and regulations may adversely affect the Trust.
• Any Loans will reduce the funds available for distribution and increase the risk of loss.
• The prepayment premiums associated with a Loan may negatively affect the Trust’s exit strategies.
• If the Trust is unable to sell or otherwise dispose of the Property before the maturity date of the Loan, it may be unable to repay the Loan and may have to cause a Transfer Distribution.
• The Loan Documents contain various restrictive covenants, and if the Trust fails to satisfy or violate these covenants the Lender may declare the Loan in default.
• There is no public market for the Interests.
• An investment in the Interests may not be diversified as to the type of asset or geographic location.
• The Interests are not registered with the Securities and Exchange Commission or any state securities commissions.
• Investors may not realize a return on their investment for years, if at all.
• The Trust is not providing any prospective investor with separate legal, accounting or business advice or representation. There are various tax risks, including the risk that an acquisition of an Interest may not qualify as a Section 1031 Exchange.