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Information provided on this page is intended to be informative and not to be used in place of tax or investment advice. To find out how this information pertains to you and your particular situation please reach out to our team at (888) 800-2854.
For investors, a 1031 Exchange may provide an effective tax strategy for tax deferral as part of succession and estate planning. Internal Revenue Code Section 1031 provides that “no gain or loss shall be recognized on the exchange of real property held for productive use in a trade or business or for investment if such real property is exchanged solely for real property of like kind which is to be held either for productive use in a trade or business or for investment”.
Examples of Like-Kind Properties:
Potential Benefits of a 1031 Exchange
For complete tax deferral, investors must:
A Delaware Statutory Trust (DST) is a distinct legal entity created under Delaware law that permits fractional ownership of real estate assets that may be used in a 1031 Exchange. However, to use a DST in a 1031 Exchange syndication program, it must comply with the requirements of IRS Revenue Ruling 2004-86, so that a beneficial interest in the trust is treated as an undivided fractional interest in real estate for federal income tax purposes (as opposed to a security or other prohibited interest that would not be treated as real property under Section 1031). An Exchanger can defer taxes by investing in a DST rather than in a whole property.
Why Consider a DST?
Why Invest Cash into DST’s?
The potential benefits of a DST program are not restricted to 1031 Exchange funds. Investors may also choose to invest directly into a DST, which may provide the following potential benefits:
Limitations on a DST:
The DST must adhere to the following prohibitions, which are commonly referred to as the Seven Deadly Sins (See IRS Revenue Ruling 2004-86):
General Real Estate RiskAll forms of real estate investing are speculative and involve a high degree of risk. Investors should be able to bear the complete loss of an investment. All real estate is generally subject to the risks of increased and ongoing vacancy, problematic tenants, economic downturns, physical damage or loss, unexpected repairs and maintenance, eminent domain, negative rezoning, blight, environmental damage and liability, and overall valuation fluctuations that may be outside of the owner’s control.
Specific 1031 Exchange Risks1031 Exchanges are highly complex and failure to comply with the stringent requirements may result in a complete loss of the desired tax deferral. Investors should carefully consult with independent tax and legal counsel prior to initiating, and while performing, a tax-deferred exchange.There are numerous section 1031 rules and requirements including, but not limited to: seller cannot receive or control the net sales proceeds, replacement property must be like-kind to the relinquished property, the original replacement property must be identified within 45 days from the sale of the property, the replacement property must be acquired within 180 days from the sale of the original property, and the debt placed or assumed on the replacement property must be equal or greater than the debt encumbering the relinquished property.
IlliquidityThere is no significantly established secondary market for syndicated, fractionalized TIC and DST ownership interests. The transfer of these interests may also be legally restricted. Investors should carefully consider both their ongoing liquidity needs and estate planning goals prior to investing in such an interest.
Limited DiversificationMost offerings are for ownership interests in a single property, and any desired diversification must be achieved with other real estate investments.
No Guarantee of PerformanceTCFG Wealth Management, LLC, 1031 Financial, and DST Sponsors do not guarantee ongoing distributions or overall investment performance.
Sponsor-Related FeesThere are significant fees related to the acquisition, syndication, ongoing management, and eventual disposition of any DST real estate offerings. These fees could materially impact the performance of an investment and should be carefully considered prior to any such investment. Fees and expenses are outlined and disclosed in the private placement offering memorandum that is required to be presented prior to any offer of securities.
Leverage-Related VolatilityThe use of leverage in real estate investments may increase volatility and the overall risk of loss.
Accredited Investor: Defined in Rule 501 of Regulation D to refer to investors who are financially sophisticated and have a reduced need for the protection provided by certain government filings. While each state may have additional accreditation requirements, individuals are generally considered to be accredited if they have a net worth exceeding $1,000,000 (excluding the value of your primary residence), or if they have income exceeding $200,000 in each of the two most recent years or a joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year.
Boot: Any consideration other than “like-kind” property received by the investor. Boot is subject to taxation to the extent there is capital gain. Boot can accumulate over each exchange and is retroactive back to the original relinquished property. Boot can refer to cash boot, mortgage boot and personal property.
Cash Boot: Any funds received by the Exchanger—either actually or constructively—from the sale of the relinquished property.
Constructive Receipt: Exercising control over your exchange funds or other property including having money or property from the exchange credited to your bank account or property or funds reserved for you. Being in constructive receipt of exchange funds or property may result in the disallowance of the tax-deferred, like-kind exchange transaction thereby creating a taxable sale. An example of constructive receipt would be the investor selling his relinquished property and having a closing officer hold the proceeds in an escrow or trust account on his behalf.
Direct Deeding: Either the relinquished property or the replacement property can be deeded directly from seller to buyer without deeding the property to the Qualified Intermediary. Direct deeding may eliminate paying transfer taxes twice on the sale of the relinquished property and purchase of the replacement property.
Exchange Agreement: The written agreement defining the transfer of the relinquished property, the subsequent receipt of the replacement property and the restrictions on the exchange proceeds during the exchange period. The exchange agreement specifies all the terms of the relationship between the investor and the qualified intermediary.
Exchange Period: The period of time during which an investor must complete the acquisition of the replacement property in a like-kind exchange transaction. The exchange period is 180 calendar days from the transfer of the investor’s relinquished property, or the due date (including extensions) of the investor’s income tax return for the year in which the tax-deferred, like-kind exchange transaction took place (whichever is earlier), and is not extended due to holidays or weekends.
Exchanger: An individual, married couple or any other entity such as a corporation, limited liability company, partnership or trust. An investor has property and would like to exchange it for new property.
Identification Period: The period of time during which an investor must identify potential replacement properties for a tax-deferred, like-kind exchange. The period is 45 calendar days from the transfer of the investor’s relinquished property and is not extended due to holidays or weekends.
Like-Kind Property: Any two assets or properties that are considered to be the same type under federal income tax law, making an exchange between them tax deferred. Like-kind real estate property is basically any real estate that is not held for personal use, including a second home which is held for investment purposes. Following the Tax Cut and Jobs Act of 2017, like-kind property is limited to real property.
Mortgage Boot: Mortgage Boot occurs when the Exchanger does not acquire debt that is equal to or greater than the debt that was paid off, and is therefore ‘relieved’ of debt, which is perceived as taking a monetary benefit out of the exchange. Therefore, the debt relief portion is taxable, unless offset by adding equivalent cash to the transaction.
Private Placement Memorandum (“PPM”): A legal document stating the objectives, risks and terms of investment involved with a private placement. This may include items such as the financial statements, management biographies, detailed description of the business, etc. A PPM serves to provide buyers with information on the offering and to protect the sponsor from the liability associated with selling unregistered securities.
Qualified Intermediary: Also called: intermediary, QI, accommodator, facilitator, or qualified escrow holder. The QI is a third party that holds exchange funds and helps to facilitate the exchange.
Regulation D Offering: An exemption from registration of securities offerings under U.S. Securities laws often used for TIC and DST ownership investments where, among other factors, investors generally must be qualified as accredited investors.
Relinquished Property: The original property given up by the investor which is sold by the qualified intermediary. This property is sometimes also referred to as the sale, “downleg” or “Phase I” property.
Replacement Property: The like-kind property to be acquired or received by the investor from qualified intermediary’s purchase from the seller in a tax-deferred exchange transaction. This property is sometimes also referred to as the purchase, “upleg” or “Phase II” property.
Reverse Exchange: A reverse 1031 Exchange represents a tax deferment strategy when for a variety of reasons, the replacement property must be purchased before the relinquished or old property is sold. It is more complex than a forward 1031 Exchange and requires careful planning.
Sponsor: The party offering a commercial property asset available for sale to investors. The sponsor purchases the property, arranges the financing (if any), sells the fractionalized interests to individual investors, and typically handles accounting and property management after closing.
The Certified Financial Planner (CFP) Board’s Code and Standards defines Financial Planning as “a collaborative process that helps maximize a client’s potential for meeting life goals through Financial Advice that integrates relevant elements of the Client’s personal and financial circumstances.”
In this context, it’s notable that Financial Planning is about a process and not just the document/plan itself. This process evaluates your current financial condition, helps you determine and prioritize what is important to you, and implements guidelines to help you meet your current and future financial needs and wishes.
The Certified Financial Planner Board of Standards provides that financial planning consists of the following 7 steps:
1) Understanding your personal and financial Circumstances. This includes gathering quantitative and qualitative information, analyzing the information, and identifying any pertinent gaps in the information.
2) Identify and select Goals, including a discussion on how the selection of one goal may impact other goals.
3) Analyze the current course of action and potential recommendations. This should be evaluated based on the advantages and disadvantages of the current course of action, and the advantages and disadvantages of potential recommendations.
4) Develop financial planning recommendations including not only what you should do, but the timing and priority of recommendations, and whether recommendations are independent or must be implemented jointly.
5) Presenting financial planning recommendations and discussing how the recommendations were determined.
6) If it is determined as part of the scope of your engagement, implementing recommendations, including which products or services will be used, and who has the responsibility to implement them.
7) Monitor progress and update the plan within scope of the engagement, by defining which actions, products, or services will be our responsibility to monitor and provide subsequent recommendations.
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