1031 Exchange Tax Strategies

Provided by Wealth Investment Services, LLC

While a 1031 exchange can be a helpful tool for real estate investors looking to defer taxes on capital gains and depreciation recapture taxes, investors may consider several exchange strategies. These alternatives offer different advantages and disadvantages that may be more suitable for certain types of investors or investment strategies. A few of these strategies include, but may not be limited to:

Delaware Statutory Trust

Delaware Statutory Trusts (DSTs) are a type of trust formed under Delaware law for accredited investors. The structure allows investors to 1031 exchange a relinquished property into a replacement property to defer some or all capital gains tax that would have been due upon sale of the relinquished property. This can be favorable for investors seeking the opportunity to leverage greater purchasing power by deferring the tax. While portfolio diversification and passive management may be benefits, DSTs are speculative and are driven by an underlying asset, so they are exposed to the same risks of direct property investments, such as illiquidity, loss of value, and other macroeconomic risks, to name a few. Additionally, there are downsides due to its active management, which may include various fees and back-end costs. However, many investors may find the benefit of tax deferral savings outweighs the fees and costs. Each investor is different, so speaking to a financial professional or tax professional is important to ensure it is the right fit.

Qualified Opportunity Zone

Qualified Opportunity zones (QOZs) are designated economically distressed communities that provide tax incentives for those who invest in these areas. Investing in QOZs long-term can receive tiered reductions in capital gains taxes and even the elimination of capital gains tax generated in the fund altogether. This can be used for investors looking to help invest and support low-income communities and diversify their tax and investment strategies. Adversely, QOZs pose various risks, such as illiquidity, loss of capital, may not be able to appreciate as predictably as more established areas and have no guarantee of favorable performance.

Oil & Gas

While not all oil & gas investments meet 1031 exchange like-kind requirements, a few do, such as a working interest. A working interest is the exclusive rights to enter land and extract oil, gas, and minerals, and involves the right and cost obligation to explore. Investors are due a percentage of potential profit generated from production but is also responsible for a share of operation costs. A successful 1031 exchange requires property be exchanged and a working interest in gas, oil and minerals is considered a real property interest making it eligible for an exchange.

Tenant-in-Common

Tenants-in-Common (TIC) is another type of co-ownership structure commonly used to purchase commercial properties that one individual may not be able to access alone, such as Walgreens or Dollar General, for example, and usually includes professional property management. This exchange helps defer capital gains tax on the profits from an investor's relinquished property. This type of exchange structure may be more complicated since it involves other members and is subject to many rules.

721 Exchanges/UPREITs

While an investor cannot directly 1031 exchange into a Real Estate Investment Trust (REIT), a 721 or UPREIT (Umbrella Partnership Real Estate Investment Trust) allows investors to defer capital gains taxes on the sale of a property by contributing their appreciated properties to a partnership in exchange for shares in a REIT property. UPREITS are most common in an investor's final 1031 exchange. Moreover, most exit strategies in a DST involve selling the properties and distributing the proceeds to investors- but some sponsors allow them to roll their proceeds into a REIT through an UPREIT. Benefits may also include a diversified portfolio of real estate assets, liquidity, and access to professional management. However, UPREITs also come with risks, including declining property values, management fees due to professional oversight, and complications in tax filing requirements, for example.

Conclusion

There are several 1031 exchange strategies that real estate investors may consider. Each of these alternatives offers different advantages and disadvantages that may be suitable depending on an investor's risk tolerance, investment objectives, and investment strategies. Investors should carefully consider their options and consult with experienced professionals to determine the best course of action for their specific needs and goals.

Steve Erickson is a Wealth Strategist with the Washington office of Wealth Investment Services, LLC, and Sam Scarpone in the Oregon office. For more information contact them at serickson@wealthinvests.com or sscarpone@wealthinvests.com. 

Because investor situations and objectives vary this information is not intended to indicate suitability for any particular investor.

This is for informational purposes only, does not constitute individual investment advice, and should not be relied upon as tax or legal advice. Please consult the appropriate professional regarding your individual circumstance.

Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated.

Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.

There are material risks associated with investing in private placements, Delaware Statutory Trusts ("DSTs") and real estate securities including the potential loss of the entire investment principal, illiquidity, tenant vacancies impacting income and revenue, general and real estate market conditions, lack of operating history, interest rate risks, competition, including the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and investors should read the PPM carefully before investing paying special attention to the risk section.

Certain Qualified Opportunity Zone (QOZ) areas may not be able to appreciate as predictably as more established areas. Some neighborhoods may be more accommodating to development than others, impacting the success of the investment. Development and redevelopment of real estate traditionally have more risk than other types of real estate strategies. The availability and cost of construction and development financing is uncertain and represents a risk inherent in the execution of a QOF strategy. The rules and regulations of the QOZ Program are complex, compliance with the QOZ Program comes with significant challenges. QOFs tend to be illiquid investments for ten or more years. Any discussion regarding "Qualified Opportunity Zones" - including the viability of recycling proceeds from a sale or buyout - is based on advice received regarding the interpretation of provisions of the Tax Cut and Jobs Act of 2017 (the "Jobs Act") and relevant guidance's, including, among other things, two sets of proposed regulations and the final regulations issued by the IRS and Treasury Department in December of 2019. A number of unanswered questions still exist, and various uncertainties remain as ta the interpretation of the Jobs Act and the rules related to Opportunity Zones investments. We cannot predict what impact, if any.

DST 1031 properties are only available to accredited investors (typically defined as having a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last two years; or have an active Series 7, Series 82, or Series 65. Individuals holding a Series 66 do not fall under this definition). If you are unsure if you are an accredited investor and/or an accredited entity, please verify with your CPA and Attorney.

Oil and gas mineral royalty Interests are illiquid investments, are speculative and involve a high degree of risk; investors should be able to bear the complete loss of their investment. In addition, the oil and gas market is affected by many factors, such as general economic conditions, oil and natural gas pricing, financing markets, supply and demand, and other factors that are beyond an Offeror's control. All these factors could restrict an investor's ability ta sell their mineral/royalty interests.

An UPREIT (umbrella partnership real estate investment trust) is a REIT structure that allows property owners to exchange their property and defer taxes on the sale of property in exchange for UPREIT units though capital gains taxes on UPREIT units are subject to standard REIT taxation. UPREITs are generally subject to Internal Revenue Code (IRC) Section 721 exchanges.

Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Depending on the furnishing representative's relationship, advisory services may be offered through Concorde Asset Management, LLC (CAM), an SEC registered investment adviser; and insurance may be offered through Concorde Insurance Agency, Inc. The furnishing representative and their firm are independent of CIS, CAM, and CIA. 07/2023