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We can assist you as needed in locating a Qualified Intermediary to receive and hold the proceeds of your real estate sale and to distribute these funds for the purchase of a new securitized property(or properties) as part of an exchange.
We can then help you assess the suitability of a variety of securitized exchange properties and help you understand the risks and opportunities within these real estate investments.
We can then assist you in making your ultimate real estate exchange decision, formally identifying the property(or properties) for exchange and completing the necessary documentation to accomplish your desired transaction(s) under the applicable rules.
We will then be available to you throughout the term of the exchange investment to assist and represent you as needed.
The tax code provides a real estate investor the opportunity to perform exchanges of real estate and thereby defer the payment of tax on capital gains. These exchanges can be done on a delayed basis. The tax code further allows the investor and heirs to escape the payment of tax upon the death of the investor, as the basis of the real estate holding is stepped up to market value. These provisions make real estate exchanges extremely valuable.
The tax code provides for the exchange of “like kind” property. “Like kind” means the properties are of the same nature or character(i.e. are held for investment or business use), even if they differ in grade or quality. Real property is generally considered like kind, regardless of whether the properties are improved or unimproved. However, a real property within the United States and a real property outside the United States would not be considered like kind.
Taxpayers who hold real estate as inventory, or who purchase real estate professionally for re-sale, are considered “dealers”. These properties are not eligible for Section 1031 treatment. However, if a taxpayer is a dealer and also an investor, he or she can use Section 1031 on qualifying properties. Personal use property does not qualify for Section 1031.
The primary purpose of doing a delayed exchange is to defer capital gains taxes and the recapture of any depreciation on the property sold. To make sure that this goal is properly achieved, it is vital that the exchanger comply with all rules required by the Internal Revenue Service.
Section 1031 of the Internal Revenue Code defines these rules, and the Like-Kind Exchange Regulations, issued by the US Department of the Treasury, provides interpretations of the IRS rules.
The three primary rules to follow for determining taxation on an exchange are:
The extent that either of these rules are violated determines the tax liability after executing the exchange. Partial exchanges qualify for a partial tax-deferral treatment. Any proceeds of a sale that are not exchanged are considered “boot” and are taxable. To qualify as a 1031 exchange, the proceeds from the sale of a property to be exchanged must be deposited directly from escrow with a Qualified Intermediary, who must directly purchase the exchanged-for property for the investor, subject to the following timelines:
Identification Period: The exchanger must identify with the Qualified Intermediary one or more replacement properties to purchase with the proceeds of the sale within 45 days from the sale of the relinquished property. This 45-day timeline must be followed under any and all circumstances and is not extendable in any way(except by action of the federal government), even if the 45th day falls on a Saturday, Sunday or a legal US holiday.
Exchange Period: The exchanger must complete the purchase of property from the proceeds of the sale within 180 days of the date of the original sale or by the due date for the exchanger’s tax return for that taxable year in which the transfer of the relinquished property has occurred, whichever occurs earlier. This timeline also is not extendable under any circumstances(except by action of the federal government), even if the 180th day falls on a Saturday, Sunday or legal US holiday.
There are other rules and rules within rules that must be followed. We can help you understand them and comply with them.
Risk Disclosure: There is no guarantee that any strategy will be successful or achieve its investment objective. All real estate investments have the potential to lose value during the life of the investments. The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities. All financed real estate investments have potential for foreclosure. 1031 exchanges are commonly offered through private placement offerings and are illiquid securities. There is no secondary market for these investments. Like any investment in real estate, if a property unexpectedly loses tenants or sustains substantial damage, there is potential for suspension of cash flow distributions. Costs associated with the transaction may impact investors’ returns and may outweigh the tax benefits.
The Delaware Statutory Trust(DST) is a vehicle which was created to facilitate securitized real estate exchange transactions. Revenue Ruling 2004-86(https://www.irs.gov/irb/2004-33_IRB#RR-2004-86), released by the IRS in 2004, allows the use of a DST to acquire real estate where the beneficial interests in the trust will be treated as direct interests in a replacement property for the purposes of a § 1031 exchange.
DST investment allows investors to pool their funds together to purchase institutional-quality properties. If properly structured, DST investors are not in partnership with the other investors. They are simply co-owners in a common property managed by the investment sponsor firm.
DST investments may simplify property owners’ lives through the elimination of time-consuming and costly management problems, as they are passive investments in real estate. DST owners receive all of the benefits of traditional real estate ownership(100% pass through of their pro rata share of distributable cash flow, deductible expenses, depreciation, and all appreciation upon future sale) without the hassles of property management.
A DST is structured so that each beneficiary(investor) owns a beneficial interest in the trust. The managing Trustee of the DST is either the Sponsor or an affiliate of the Sponsor. The DST holds title to 100% of the interest in the property. Tax reporting for a DST is done on a Schedule E utilizing property operating information provided by the Sponsor. The aforementioned IRS Revenue Ruling 2004-86 (https://www.irs.gov/irb/2004-33_IRB#RR-2004-86) sets forth parameters a DST must meet in order to be viewed as a grantor trust and qualify for a viable tax deferring vehicle:
The Sponsor has negotiated the loan terms for the property prior to acquiring the property. These terms may not be amended or renegotiated over the term of the DST. In the event the property is not sold before the loan matures, there are provisions in place to convert the DST to a limited liability company(LLC). This allows the Trustee(Sponsor) the ability to take the necessary actions to remedy the situation. However, if this occurs, investors will not be able to conduct another 1031 exchange upon the sale of the property.
The investors, through the Trust Agreement, enter into a Master Lease with the Trustee in order to avoid having to renegotiate leases directly or enter directly into new leases with the actual tenants. The Trustee is free to renegotiate or enter into leases with tenants and pass through bonus rent to the investors.
Any major improvements will be done or have been done by the seller prior to the Sponsor purchasing the property. Normal “turnover” expenses fall within the DST guidelines and do not create an issue with the DST structure. Thus, typically DST investments involved fairly stabilized properties that will be in roughly the same form at the outset of the investment as they will be upon future sale.
The Trustee shall distribute all net proceeds to the investors, typically on a monthly basis, retaining only those reserves necessary to manage the property.
The DST cannot sell assets and reinvest the proceeds to continue its existence. Reinvestment of proceeds is the responsibility of the investor. The DST structure allows investors or beneficial owners to conduct their own 1031 tax deferred exchange once the DST has sold its asset and returned the sale proceeds to the investors/beneficial owners.
All cash reserves to be used in the management of the property and proceeds from the sale of property prior to distribution must be held in liquid money market type accounts.
There can be no additional capital calls to the DST. As part of the due diligence, the Sponsor conservatively anticipates the amount needed to properly maintain the property over the holding period, and those reserves are included in the initial capital raise. It is imperative that the Sponsor estimate the necessary reserves, as the investors cannot provide additional reserves after the investment is made.