What is a 1031 Exchange?
A typical 1031 exchange is an exchange that occurs when you sell one investment property in order to purchase another. It is a tax-deferred exchange that allows you to defer capital gains taxes as long as you are purchasing another “like-kind” property. If you were to just sell your current investment property to purchase another, you would typically have to pay a significant amount in capital gain taxes. However, if the transaction is done under a 1031 Exchange, it is a tax-deferred exchange that allows you to defer capital gains taxes as long as you are purchasing another “like-kind” property.
What do I have to do in order to do a 1031 Exchange?
Adherence to the legal requirements of Section 1031 of the IRS Code is required for a successful exchange. You should be aware of the 4 basic requirements when entering into a delayed exchange and you should consult a tax professional and/or attorney to ensure proper adherence to the tax code.
The 4 basic requirements are:
1) PROPERTY QUALIFICATIONS
Properties involved in the exchange must be “like-kind. Like-kind does not mean exact-kind.
2) IDENTIFICATION
Identification of all potential replacement properties is required within 45 DAYS of the close of your escrow, which is a VERY short amount of time and this can be very stressful. If you do not name a property(ies) within those 45 days you will be subject to paying hefty Capital Gains Taxes.
Identification of the replacement property(ies) must be in writing and not vague. There are 2 rules when identifying a replacement property:
- 3 Property Rule
The 3 Property Rule allows for identification of any 3 properties, any price, anywhere in the U.S.
- 200% Rule
There is an option for identifying more than 3 properties. Within this rule, 4 or more properties can be identified but the combined value of all the identified properties cannot exceed 200% of the property sold.
3) TIMELINE
There is a maximum of 180 days to complete the exchange. Time starts on the close of escrow of the relinquished property and the replacement property must be acquired by day 180. NO EXCEPTIONS.
4) TAX DEFERIAL
2 things must happen to defer 100% of the capital gains:
- The purchased property(s), must be equal or greater in value to the property sold.
- All the cash that was generated from the sale of the relinquished property must be reinvested into the new property(s).
What is a DST?
A Delaware Statutory Trust (DST) is a Securitized Real Estate product. The DST entity structure allows the smaller investor to own a fractional interest in large, institutional quality and professionally managed commercial property(s) along with other investors, not as limited partners, but as individual owners within a trust. Each owner receives their % share of the cash flow income, tax benefits (deferral when entering on a 1031 exchange & depreciation if there’s leverage on the investment), and potential asset appreciation.
Benefits of a DST:
Fractional Ownership: Makes fractional ownership available to the everyday investor. Low minimum investment. Allows for better diversification of your 1031 proceeds.
IRS-Approved as 1031 Exchange Replacement Property: More options for your exchange.
“Pre-Packaged” Investments: Save time. You can name a property that’s offered in the DST in a matter of days relieving the stress of finding a property yourself within the 45 days.
Institutional-Quality Real Estate: . Access to asset types you couldn’t afford on your own. Property types may include large multi-family apartments, Class A offices, industrial facilities, medical offices, storage facilities and more. You can also diversify into multiple classes of properties to spread the risk if you would like.
Management Free: The DST is the sole decision-making authority on the investor’s behalf, responsible for all property management, asset management and property operations.
No out-of-pocket expenses: No bills or unforeseen expenses. Predictable income
If you currently own an investment property and no longer want to perform the duties of a landlord a DTS 1031 Exchange is an option worth exploring.
