Exploring 1031 Exchange Alternatives for Real Estate

If you're looking to sell a property and invest in another, you might be familiar with a 1031 exchange. However, there are other options to consider.

A 1031 exchange allows you to defer taxes on the sale of a property by investing in a similar property, but it has its own set of rules and requirements.

One of the main drawbacks of a 1031 exchange is the complexity and time-consuming process of setting it up.

The alternative to a 1031 exchange is to use a Delaware statutory trust (DST), which can be a more straightforward option.

So, what is an exchange in the context of 1031 exchanges? An exchange is a transaction that allows investors to defer paying capital gains taxes on the sale of investment property by reinvesting the proceeds of the sale into another "like-kind" property.

This means that the investor can exchange one property for another without incurring immediate tax liability. A "like-kind property" refers to real estate of equal or greater value that is also used for investment purposes.

Take a look at this: 1031 like Kind Exchange

The benefits of executing a 1031 exchange include saving money by deferring capital gains taxes, diversifying your portfolio with new and/or more properties, and potentially improving cash flow with rental income from more profitable properties.

Here are some key rules to keep in mind: you must identify a replacement property within 45 days of the sale of the original property, and the entire exchange must be completed within 180 days. These two windows occur concurrently.

This means that you have a relatively short timeframe to find and close on a new property, so it's essential to have a solid plan in place before initiating the exchange process.

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If you're looking for alternatives to a 1031 exchange, you have a few options to consider. A 721 exchange, also known as an UPREIT, can potentially be used, but it requires specific steps and agreements from all parties involved.

One alternative is a Delaware Statutory Trust, which allows individual investors to purchase shares in a trust that owns a property, giving them a pro-rata share of the income and profits. However, a DST investment on its own is not eligible for tax deferral.

Another option is a Deferred Sales Trust, which allows sellers to receive payment in installments over a period of time, spreading out their capital gains tax burden. This is a key difference from a 1031 or 721 exchange, where the property is exchanged or sold outright.

See what others are reading: How to Report 1031 Exchange on Tax Return

A Delaware Statutory Trust (DST) is a special type of trust formed under Delaware law for conducting business. It allows a professional real estate firm to manage the day-to-day operations of a property.

Individual investors can purchase shares in the DST to gain fractional ownership of the underlying property. As owners of a fractional interest, investors are entitled to their pro-rata share of the income and profits it produces.

A DST investment is not eligible for tax deferral on its own. However, it can be an eligible replacement property in a 1031 Exchange.

To qualify for tax deferral, all the rules of a 1031 Exchange must still be followed, including the value of the investment. It's best to review the rules in the internal revenue code (IRC) and work with a Qualified Intermediary to ensure compliance.

Expand your knowledge: 1031 Exchange 180 Day Rule

Tenants in Common Cash Out is a strategy that allows investors to access their original investment without incurring taxes. This is done by purchasing a commercial property with cash and then refinancing it with some leverage.

The property can be refinanced after a year or two, providing investors with a significant portion of their original investment back. This is typically between 40% and 60% of the property's then market value.

With the cash out, investors can gain liquidity for other uses or reinvest it in the TIC investment. The remaining equity stays in the TIC investment, allowing it to continue generating returns.

Related reading: Tenants in Common 1031 Exchange

A Deferred Sales Trust is a clever way to manage capital gains taxes. In this type of transaction, a seller enters into a sales contract with a buyer, but instead of receiving payment at closing, they receive payment in installments over a chosen period of time.

For example, if a seller sells their property for $1,000,000, they may negotiate the sales contract to receive four annual payments of $250,000 each. This allows them to spread out their capital gains tax burden over a long period of time.

There's a key difference between a Deferred Sales Trust and a 1031 or 721 Exchange. In those transactions, the property owner doesn't sell outright, they exchange it for another one or for shares in a REIT.

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A 721 exchange, also known as an UPREIT, is a type of structure that allows investors to defer capital gains taxes on the sale of a property.

It's essentially a partnership where you contribute your property to an umbrella partnership in return for units in that partnership.

This means you don't sell your asset to another buyer, but instead, you contribute it to the partnership in exchange for units that own a diversified portfolio of multiple assets.

In a 721 exchange, you may be subject to certain provisions, such as how long it will take for your shares to vest in the REIT or how long before you can sell them.

One of the benefits of a 721 exchange is that it doesn't cause taxable events, as you aren't required to pay investment taxes until shares are redeemed.

You can spread tax payments across time, or investors can do it all at once.

Intriguing read: 1031 Exchange Properties Sale

Many investors opt for 721 exchanges as an alternative to 1031 exchanges because of the managerial responsibilities and tax capabilities.

In a 721 exchange, you'll have daily management and property ownership responsibilities, including property maintenance, rent collection, and property tenants.

Investors looking to diversify their portfolio may find 721 exchanges to be a good fit.

Recommended read: 721 Exchange vs 1031 Exchange

One of the key benefits of 721 exchanges is the ability to defer capital gains tax through tax-deferred exchanges of appreciated real estate assets.

This can be a huge advantage for investors, allowing them to reinvest their gains without paying taxes upfront.

OP Units, or operating partnership shares, can be converted into REIT shares, which can be sold for operating partnerships, providing another layer of flexibility.

REITs require distributing 90 percent of an investor’s taxable income via dividends paid to shareholders, which can be a helpful tool for continuously deferring capital gains and increasing passive income.

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Opportunity Zone Funds can be a game-changer for investors looking to minimize their tax liability. A Qualified Opportunity Zone Fund (QOF) is a fund run by a professional firm that helps manage the logistics of investing in an Opportunity Zone.

QOFs are often run by major real estate companies and financial firms and can be easily found with a simple internet search. They can be a great option for individual investors who may not have the resources or expertise to invest in Opportunity Zones on their own.

Investors can benefit from a 10% reduction in capital gains taxes if they hold a QOF investment for 5-7 years, a 15% reduction for 7-10 years, and complete elimination of capital gains taxes if they hold it for more than 10 years.

Here are the tax benefits of investing in a QOF:

Tax advantages are a significant draw for investors choosing 721 exchanges. Many investors opt for 721 exchanges to defer capital gains tax through tax-deferred exchanges of appreciated real estate assets.

Operating partnership shares, also known as OP Units, can convert into REIT shares. This conversion can be sold for operating partnerships, providing a way to access cash.

REITs require distributing 90 percent of an investor’s taxable income via dividends paid to shareholders. These dividends become declared annually by REITs, typically distributed monthly or quarterly.

Continuous deferral of capital gains and increased passive income can be achieved through REITs.

At Canyon View Capital, we've got over four decades of experience managing real estate that has amassed over $1B in aggregated value. Our team has a deep understanding of the real estate market and can help you explore alternative investment options.

We know that a 1031 exchange can be a great tool, but it also comes with specific requirements and a narrow window for execution. This can be daunting, even for experienced investors.

Our team at Canyon View Capital is dedicated to guiding you through the entire process and ensuring you have a thorough understanding of all your options.

You can manage your real estate assets yourself, but it requires a lot of time and expertise.

For those who don't have the time or expertise, partnering with a private equity firm can be a great option.

Private equity firms like the one mentioned in the article can help investors place their capital in a tax deferral option.

The most common tax deferral options are the fractional purchase of a property with a tenants in common ownership structure or the placement of funds in a Delaware Statutory Trust.

In both cases, the investor can defer capital gains taxes while the private equity firm handles the logistics of the transaction.

Private equity firms can do all the hard work of finding, financing, and managing the property, making it a compelling option for investors who want to outsource this work.

A fresh viewpoint: 1031 Exchange Time Limit

Delaware Statutory Trust (DST) real estate has been a great way for investors to participate in passive, professionally managed real estate for their 1031 exchanges. The DST investment structure of real estate ownership has given investors the potential to diversify across several property sectors, geographic locations and with various managers.

See what others are reading: Dst 1031 Exchange

Investors can utilize a 1031 exchange into DST 1031 properties, allowing them to focus on areas of life like family, hobbies and travel instead of dealing with tenants or just having to be constantly concerned with the value of hands-on real estate and the best time to sell.

A qualified opportunity zone fund can invest in any real estate property that is located within a designated “opportunity zone” – an underserved area or one that needs economical uplifting.

Canyon View Capital has over four decades of experience managing real estate that has amassed over $1B in aggregated value.

Our team at Canyon View Capital understands that a 1031 exchange can be a great tool for deferring taxes, but it also comes with a narrow window for execution and specific requirements that can be difficult to meet.

We can help you understand the process of a 1031 exchange and accommodate your needs accurately and swiftly.

At Canyon View Capital, we're dedicated to guiding you through the entire process and ensuring that you have a thorough understanding of all your options.

We want to help you make the best investment decisions possible, and we have the experience and expertise to do just that.