So you’re looking at investing in a 1031 exchange real estate property, but don’t know where to start? Whether you’re looking to defer your capital gains, to reset the depreciation clock, or are just looking for a better property to invest in, considering this IRS-recognized method of tax deferral can be the way to go.
But when looking at an investment property, especially one involved in a 1031 exchange, how do you narrow down the property to best suit your needs? Read on for tips to select the perfect opportunity.
1031 Exchange Real Estate Ownership Options
You can choose between whole-property and fractional ownership. Some of the pros and cons to these options include:
- Whole property: Complete control over property, including construction and lease options
- Fractionally-owned properties: short closing date window, ability to have passive ownership (as opposed to an active role in property management)
Of course, you can also choose to invest in a DST, or a Delaware Statutory Trust. We’ll get into that later, as there are an entirely different set of risk/reward with that path of 1031 exchange.
Keep in mind that Section 1031 exchanges cannot apply to deals involving:
- Partnership interests
- Trust securities
- Stocks, bonds or notes
- Other debt
Also remember that you only have 180 days to completely close on your new investment property. So time is of the essence when you decide to move forward with this type of real estate exchange.
When to do a 1031 Exchange
So how do you know when your property is ripe for a like exchange?
- Do you see yourself with the perfect secondary property that you’re ready to trade up for?
- Do you want to diversify your real estate portfolio with multiple properties, as opposed to one investment property, of which your properties all have the same valuation?
Keep in mind that there are several different time frames in which to complete this 1031 Exchange, including before you’ve sold your initial property (reverse exchange), within 180 days of selling your initial property (forward exchange), and an improvement exchange, in which the delayed tax dollars can go towards construction and renovation of the newly purchase property. All of these factors should go into play when considering the perfect time frame for this investment opportunity.
1031 DST (Delaware Statutory Trust) Properties
Despite the name, anyone in the US can qualify for a Delaware Statutory Trust. This is a great way to get involved in real estate investments with minimal personal risk. Even with a DST, investors can still consider whole-property versus fractional-property investments, but the property is still held within the framework of a trust.
DSTs differ from other 1031 Exchange fractional ownership strategies in that each investor does not own a fractional, undivided interest in a property as a co-owner. The trust manager holds all of the decision making process for the property, but in return, the investors have limited liability, no additional LLC costs and all have mutually-beneficial interests from the ownership of the property.
If this is all sounding great to you, keep in mind a few pros (ability for multi-property diversification, better exit strategies, lower minimum investments) and cons (lack of liquidity, tax code edits resulting in impacts to deferment).
How to pick the perfect 1031 exchange property
Now that we’ve covered what the do’s and don’ts of these properties, it’s time for the fun part: how to select that investment property to better your real estate portfolio.
While you may see the phrase “like-kind” and think immediately of the budget, there are several non-monetary factors that play into this turn of phrase. Like-kind properties refer to real estate characteristics, as opposed to quality. This broadens the ability to do this type of exchange, no matter what kind of investment properties you own or are looking at. Like-kind applies to properties of different zoning, or even of empty lots for fully-constructed buildings. You just must be looking at investment properties (so you should expect to own them for at least two years) that you do not intend to use for personal use, of equal or greater value than your current property.
There are three rules when selecting your 1031 Exchange property:
- Three property rule: identify three potential properties, regardless of market value
- 200% rule: As many properties as you want! (As long as their total value does not exceed more than 200% of your current property’s value)
- 95% rule: Once again, as many properties as you want! (But in your acquisition of said properties, you must purchase them for at least 95% of their valuation)
How can we help?
Preferred 1031 is here for you when you’re considering this type of real estate transaction and can serve as your Qualified Intermediary during this process. We work with clients not just across Texas, but throughout all 50 states. Our services include:
- Provide ‘transaction specific’ education for clients regarding 1031 exchange processes and structure
- Educate clients on legacy wealth building advantages of 1031 exchanges and 1031 exchange real estate investment opportunities
- Provide a network of qualified Replacement Property to complete a 1031 exchange in the event the client is unable to identify property within the 45 day deadline
As a Qualified Intermediary, Preferred 1031, is prohibited from providing tax or legal advice.
Taxpayer must seek such counsel from their advisors. For more information on 1031 Exchanges, please set up a free consultation with one of our advisors by contacting us at: