The Role of 1031 Exchanges in Estate Planning

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Completing a 1031 exchange can allow real estate investors to defer taxes today and plan accordingly to avoid burdening their heirs with a hefty tax bill later.

A 1031 exchange involves selling a piece of real estate investment and reinvesting the proceeds in a like-kind real estate investment of equal or greater value to defer capital gains and depreciation recapture taxes ultimately.

The possible tax benefits that the 1031 exchange may offer, in combination with the option to divide assets appropriately to benefit heirs down the line, make 1031 exchanges an estate planning strategy worth considering.

Step up in cost basis

While there are reasons a real estate investor would want to sell a property in a standard transaction and pay the required taxes, this path could cost the investor upwards of 30-40% of the profits, which go straight to the IRS.

In a 1031 exchange, taxes on the gains on the relinquished property are deferred. Neither the estate nor beneficiaries face a tax liability upon the owner's death. Instead, the tax basis for the real estate investment that heirs inherit steps up to the fair market value of the date of death when they take possession. If they decide to sell the asset immediately, they will not owe capital gains taxes. They also will not be responsible for any of the depreciation recapture from which you may have benefited over the lifetime of your investment.

If the heirs wish to retain the asset, they would only be liable for taxes on gains in the future that accumulated as of the date they received the step up, up until when they sell the property. They might even consider including the property in a future 1031 exchange to defer taxes and reinvest the proceeds to defer that gain too.

Swap ‘til you drop

When investing in real estate, the properties you currently own may not be aligned with your investment objectives down the road.

It is possible to enhance your real estate portfolio over time and, through 1031 exchanges, defer the taxes each time. There is no limit to the number of 1031 exchanges an investor can complete. Investors can “swap until they drop” so long as each transaction's intent is for long-term investment rather than solely tax avoidance.

It is an opportunity to keep your own investment goals as the priority and use previous growth to have further compounded growth while also positioning your portfolio to benefit your heirs.

When there are multiple heirs

For investors who plan to leave assets to multiple heirs, it is possible to consider their financial situations when structuring your 1031 exchange.

As part of the exchange, investors may purchase multiple, or in some cases, an unlimited number of properties, setting the stage to leave different assets to different heirs. For example, let us suppose one heir will likely need to sell the investment after taking possession while another might want to hold the asset. In that case, it is possible to make it easy for both by purchasing multiple properties and listing each heir as a beneficiary of an individual asset.

Keep in mind that replacement properties must be identified within 45 calendar days after selling the relinquished property. It is viable to identify up to three replacement properties. Still, that limit can be surpassed so long as the replacement properties' value does not exceed 200% of the relinquished property, or the investor closes on at least 95% of the value of the replacement properties identified.

Consider a Delaware Statutory Trust (DST)

A Delaware Statutory Trust is a long-term passive real estate investment in which beneficial interests of a real estate trust are owned rather than individual properties directly. DSTs provide benefits for an investor's current situation by eliminating the headaches that come with active management properties while still obtaining all of the benefits of real estate ownership.

When it comes to estate planning, DST interests can be split among heirs, either ahead of time when purchasing the interests through the purchase of multiple of the same DST or upon death via reregistration based on instructions of Will’s or Entity documentation. This streamlines decisions while defusing potential estate conflicts. Investors should be aware that DSTs are typically designed to last five to ten years, and there is no active secondary market for investors should they need to sell.

1031 exchanges offer benefits for individuals looking to maximize their real estate investments today while setting up beneficiaries to continue building wealth. We always recommend consulting your tax or financial professional regarding how 1031 exchanges may fit your situation.

To learn more, please contact us at any time.

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Source: The Role of 1031 Exchanges in Estate Planning

https://www.creconsult.net/market-trends/the-role-of-1031-exchanges-in-estate-planning/

The Reverse 1031 Exchange: A Guide for Investors

 

The potential for tax savings is one of the most exciting advantages of real estate investing. Many savvy investors have enjoyed the benefits of deferring their capital gains taxes by engaging in a 1031 exchange.

This process involves replacing an investment property with a “like-kind” property. When done correctly, investors can avoid paying capital gains taxes on the sale of the original property. Even better, it’s possible to continue doing this repeatedly, so you have the potential to build even greater wealth as you upgrade from one property to the next. However, this technique has some limitations.

Property investors looking for even more flexibility may want to consider a reverse 1031 exchange. Here's what you need to know. 

Reverse 1031 Exchange: The Basics

When engaging in a traditional 1031 exchange, you must sell your original property before you can purchase a replacement property. The major drawback here is that if the original property takes a long time to sell, you could miss out on your opportunity to buy the perfect replacement property.

This is where a reverse 1031 exchange comes in. As you might guess, this transaction completely reverses the process.

First, you’ll start looking at properties you want to purchase as a replacement properties. You’ll work with a qualified intermediary to facilitate the transaction when you find one.

Once you close on your new property, you have a maximum of 45 days to identify the property you plan to sell. You’ll also have a total of 180 days to close on the property sale, completing your reverse 1031 exchange.

The Role of a Qualified Intermediary

In a traditional 1031 exchange, a qualified intermediary (QI) is needed to ensure the investor doesn’t take real or constructive possession of the investment funds at any time. Otherwise, the 1031 exchange can be invalidated, and the investor would owe all or some of the capital gains tax. When engaging in a reverse 1031 exchange, there are a couple of different ways the QI may interact with investors. One method involves investors purchasing the replacement property themselves and then transferring the title of the original property to the QI. The other is for the QI to purchase the property using financing provided by the investor and then turn the property’s title over to the investor once the original property sells.

Pros and Cons to Consider

The biggest advantage of engaging in a reverse 1031 exchange is the ability to purchase a replacement property whenever the opportunity arises. This is particularly important when there’s a lot of demand for the types of properties you’re looking for.

However, there are a few potential disadvantages. First, you’ll need to sell the original property within 180 days or lose the favorable tax treatment. It’s difficult to guarantee a property will sell, so there’s some inherent risk in this. You’ll also need to have enough money to purchase the replacement property before you’ve received the proceeds from the sale of the original property. Unless you have a significant amount of cash on hand, you may find that you have difficulty persuading a lender to provide you with the financing you need.

Other Important Considerations

There are a few other important things you need to know. First, the property rules are the same with a reverse 1031 exchange and a traditional 1031 exchange. Both properties must be “like-kind,” held for investment or business use, and must be located in the United States. If the new property costs less than the original property, you’ll also owe capital gains taxes on the difference. The same is true if the value of the new replacement property is less than the sold or relinquished property, keeping in mind you can replace debt by adding equity, but you may not replace equity by adding debt.

The Bottom Line  

If you’ve found the perfect replacement property, using a reverse 1031 exchange can allow you to lock it in without waiting for the sale of your original property. However, unless you’re confident you can close on the sale of the original property within the 180-day timeframe, you’re taking a bit of a risk.

 

Before deciding to engage in a reverse 1031 exchange, it’s a great idea to discuss your specific circumstances with your tax professional, financial advisor, and, in some cases, a real estate professional.

If you have additional questions regarding traditional or reverse 1031 exchanges, Fortitude Investment Group is here to help. Contact us today to schedule a consultation.

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Source: The Reverse 1031 Exchange: A Guide for Investors

https://www.creconsult.net/market-trends/the-reverse-1031-exchange-a-guide-for-investors/

Things to Know Before Starting a 1031 Exchange

 

If you own an investment property and are thinking of selling it, if suitable, engaging in a 1031 “like-kind” exchange may be a smart move. When done correctly, a 1031 exchange will allow you to defer all or part of the capital gains and depreciation recapture tax you would otherwise need to pay upon completion of your property sale.

1031 exchanges have many moving parts. Here is a closer look at four important things you need to know before getting started.

Assemble a Team of Experts

Putting together a team of experienced professionals right away is important to help ensure your 1031 exchange goes smoothly. The first step is to choose a reputable, Qualified Intermediary (QI).

This party is responsible for preparing and managing the important documents that apply to the relinquished and replacement properties and ensuring you comply with all necessary regulations. The QI also serves as the custodian for the sales proceeds from your property and is responsible for holding the funds until you are ready to complete the exchange. This means you absolutely must have a QI in place before you sell your property; this is not an optional aspect of your 1031 exchange.

In addition to your QI and investment professional, others you may want to add to your team include a real estate agent or broker, attorney, and CPA/Accountant. When creating your team, take the time to make sure each party you choose is intimately familiar with the ins and outs of a 1031 exchange.

Understand all Critical Timelines and Deadlines

If you fail to meet any necessary deadlines, your 1031 exchange will lose the tax advantages. Therefore, it is critical to understand the required timelines and make sure you have a plan in place to meet them.

First, you have 45 calendar days from the day you sell your relinquished property to identify your replacement property or properties (more on that in a moment). You then have a subsequent 135 days to close on those identified property(ies), totaling 180 calendar days to complete the entire exchange from sale to finish. It is important to note that these timelines run concurrently, so if you take the full 45 days to identify your property, you only will have 135 additional days to close on it.

Learn the basics of Property Selection 

IRS rules allow investors to choose from one of three identification rules. You can either,

1. Identify up to three replacement properties and close on any number of them;
2. Or, you can identify more than the three individual properties, as long as the total value doesn’t exceed 200% of the value of your relinquished property sale;
3. Or, in some special cases, you can identify an unlimited number and value of properties, so long as you close on at least 95% or more of those identified properties. 

These rules get tricky and can cause a failed exchange if not done properly. The selection process is a bit complex, so it’s best to consult with your team to ensure you’re making a suitable choice.

You will have met the first deadline once you have identified specific properties in writing to your QI. Then, you will be able to purchase one or more of the properties (consistent with IRS rules) to complete your exchange.

Always Have a Backup Plan

If anything goes wrong with your property purchase, your 1031 exchange could fail. For this reason, it is always a good idea to identify more than one replacement property. Even if you think you know which property you want to purchase, it’s crucial to have a “backup plan” in place.

Naming additional properties using the Delaware Statutory Trust (DST), for example, as your second and third options will give you additional flexibility and help ensure you aren’t left high and dry if you run into a problem closing on your first choice.

Consult with a 1031 Exchange Expert

A 1031 exchange is a common solution for many property investors. However, simple mistakes can often lead to costly results. If you’re thinking about exchanging your investment property, our 1031 exchange professionals are available to answer your questions and help guide you through the process. Contact us today!

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Source: Things to Know Before Starting a 1031 Exchange

https://www.creconsult.net/market-trends/things-to-know-before-starting-a-1031-exchange/

A Backup Plan for Boot in a 1031 Exchange

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Many 1031 exchangers think of "boot" as money proceeds from selling a relinquished property that is not reinvested in the replacement property. Often this occurs because the investor has another use for some of the proceeds and is willing to incur the taxes on the amount not reinvested.

Other times, the boot can occur because an investor cannot find a suitable replacement property to invest the entire proceeds. As you remember, the 1031 exchange requires the investor to find a replacement property of “equal or greater” value to defer taxes entirely.

An example of this ‘involuntary boot’ situation would be if you sold your rental duplex for $800,000 and found a suitable replacement property you liked, but the purchase price was only $700,000. You recognize that the $100,000 in boot is not enough to purchase another replacement property, so you would be responsible for paying capital gains tax on the uninvested $100,000.

If you find yourself in this situation, there is a backup plan that could save your exchange from taxation. If suitable, the Delaware Statutory Trust or DST is a great option.

Kick the Boot

A DST is an investment structure that meets 1031 exchange “like-kind” property requirements. It has become increasingly popular among investors looking to shed the hassles of actively managing investment property while still wanting to own income-producing real estate. A DST is a passive investment where investors own fractional shares in a property or properties that professional management companies manage.

The advantage a DST offers you if you are facing boot in your exchange is the ability to invest a relatively small amount of money – sometimes even as little as $10,000 – in high-quality institutional property that meets 1031 exchange replacement property requirements.

The DST Backup

You can also help relieve yourself from the boot in your exchange by selecting a DST as one of your potential replacement properties. Remember, you can choose more than one replacement property during your 45-day identification period. If you close on your desired replacement property and recognize you will have boot, your backup DST can still allow you to complete a full exchange with complete tax deferral. As mentioned, there are instances when 1031 exchange investors may select to receive a portion of their sale proceeds in cash and pay the tax. However, for other cases where the investor is challenged to find a suitable property to invest the total proceeds and defer their tax liability, the DST has proven to be an effective backup plan! If you would like to learn more about other advantages of a DST, contact us today or schedule an appointment on our calendars here.

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Source: A Backup Plan for Boot in a 1031 Exchange

https://www.creconsult.net/market-trends/a-backup-plan-for-boot-in-a-1031-exchange/

Inflation and 1031 Exchanges: A Guide for Real Estate Investors (Part II)

 

Our last post discussed how periods of rising inflation can affect commercial real estate assets and how today's rising price environment potentially impacts investment property owners. Depending on the types of properties an investor currently owns, and where they are located, they may find that now is a good time to evaluate one’s holdings and determine if one should make any changes. 

 

Broadly, investment real estate has historically performed well during inflationary environments compared to many other asset classes^.1 And within the commercial real estate industry, some strategies may appeal to investors who own one or a few rental properties and are concerned about sustaining their cash flow potential as inflation climbs higher.  

One of those strategies is the Delaware Statutory Trust (DST), which is becoming increasingly popular among accredited investors selling property using a 1031 exchange. This is because the DST meets "like-kind" property requirements of the 1031 exchange, affording investors the full tax-deferral benefits allowed by the IRC Code. Yet, it also has some characteristics that may help assuage investment property owners' worries today.

Tenant Stability

Many rental property owners are worried about how our high inflation will impact their tenant's ability to pay monthly rents. And many owners dislike the task of replacing current renters with new tenants.

The DST investment structure allows investment property owners to sell their property and exchange it into the DST for ownership of a fractional interest in a portfolio of properties. Because these properties are of typically institutional quality and managed by professional management firms, tenant conditions are more favorable for tenant retention.²

Portfolio Diversification

If one owns an office building or small retail center, they may have experienced what the industry refers to as "concentration risk."³ Perhaps during the pandemic, they were asked by tenants to renegotiate their leases or even provide rent relief. The office and retail sectors were hit hard during lockdowns.

DSTs often hold different types of investment property in other geographical areas, so their holdings are much more diversified. For example, a DST could hold a sizable multifamily apartment in Austin, Texas, a distribution center in Boston, Massachusetts, and a data warehouse in Orlando, Florida. Owning a fractional interest in multiple properties of different types can help manage investment risk when one property type isn't performing as well as others.

In-Place Financing

Ideally, if an investor has a loan on their investment property, it is a fixed rate note for an extended period. That would help a borrower from rising inflation because typically, as inflation increases, so do borrowing costs. But, on the other hand, if an investor needs to secure new financing, they will likely pay more for it today than a few years ago, which could lead to rising operating expenses.

DSTs generally have in-place financing on the properties negotiated at institutional levels within their portfolios. So, by exchanging an existing property into a DST, the need to secure one’s own financing is avoided. And a DST's debt is considered non-recourse to the investors, so the liability is limited.

Professional Management

Often overlooked when the cost of goods increases rapidly is the impact of more expensive materials and equipment on operating expenses. When prices are high, replacing a hot water heater or a new roof could be more costly today than just a year ago.

Since DSTs are managed by professional management firms, the trust and management group manages the expenses incurred to maintain and operate the portfolio's properties. Investors are not required to provide additional capital for repairs and maintenance as allocated within the budget. Perhaps most importantly, investors have no responsibility for operating the properties.

A Time to Consider

DSTs, as with any investment, carry certain limitations and risks investors should be familiar with prior to investing. As we have discussed here, DSTs may provide current investment property owners additional benefits to consider during periods of rising inflation. And they may also be suitable for investors during periods when inflation is not a concern.

Contact our team to schedule a no-cost consultation to learn more about how a DST 1031 exchange may help you address your current real estate portfolio concerns.

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Source: Inflation and 1031 Exchanges: A Guide for Real Estate Investors (Part II)

https://www.creconsult.net/market-trends/inflation-and-1031-exchanges-a-guide-for-real-estate-investors-part-ii/

Inflation and 1031 Exchanges: A Guide for Real Estate Investors (Part I)

 

For the past year, consumers have felt the financial pain of rapidly rising prices across various products. Whether you’re shopping for groceries, purchasing a big-ticket item, or simply filling your gas tank, it’s hard to ignore how your high inflation environment is on your purchasing power. more

In February of 2022, the annual inflation rate in the United States accelerated to 7.9% - the highest since January of 1982.¹ The Consumer Price Index (CPI) also had the highest increase in 40 years.¹ While the Federal Reserve originally forecasted inflation to ease towards the end of 2022, it now appears our high and persistent inflation will be with us for some time, as U.S. Treasury Secretary explained in a recent interview.

“We’re likely to see another year in which 12-month inflation numbers remain very uncomfortably high.”

-Janet Yellen, cnbc.com, March 10, 2022

If you’re a real estate investor, you may wonder how this rising price environment will impact your current holdings and whether you should make some adjustments to your portfolio. Here are a few things to consider before you make your next move:

How Inflation Affects Real Estate

Extended inflationary periods affect the real estate market in various ways; Some of the most significant include the influence on property values, rents, and financing.

Property Valuations Labor and construction material costs tend to rise during inflationary episodes, which can slow the development of new projects. This often creates a supply shortage for many different real estate assets, fueling demand and increasing property values. So, commercial real estate investors could benefit from property appreciation during rising inflation. Rent Rates

Many commercial property contracts contain escalation clauses, enabling owners to raise rents as their labor and property management costs increase. Annual increases are often tied to increases in the CPI. And multifamily property leases, written for shorter terms (6-12 months), allow owners to raise rents quickly, which may be at rates higher than inflation.

Financing

Inflation can impact commercial real estate investors in either a positive or negative way. For example, property owners who secured long-term fixed financing in the last few years when rates were at all-time lows will most likely avoid the need to refinance as rates increase. Conversely, owners who need financing during rising inflation will pay higher rates, typically raising their operating costs.

A Time to Buy?

While real estate still has its own risks, you may be happy to know real estate is an inflation hedging strategy. Real estate owners likely have seen property value increase over the last year and may be wondering if this would be a good time to sell.

Many other investment property owners may be weighing that same decision. One compelling strategy for potential sellers to maximize gains today yet not get clobbered with capital gains tax is to consider a 1031 exchange.

The 1031 exchange is a provision in the Tax Code, allowing investment property owners to defer capital gains and depreciation recapture taxes when exchanging an existing property for a “like-kind” replacement property.

We believe tax deferral should be increasingly important during high inflationary times, when appreciated property values may be at their highest.

We hope you have found this introduction on inflation and commercial real estate helpful. In Part II, we’ll discuss several investment concepts in further detail, including a deeper dive into four strategies that may help an individual properly allocate real estate investments during this period of inflation.

For more info, contact our team to schedule a consultation.

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Source: Inflation and 1031 Exchanges: A Guide for Real Estate Investors (Part I)

https://www.creconsult.net/market-trends/inflation-and-1031-exchanges-a-guide-for-real-estate-investors-part-i/

Is Multifamily Real Estate a Good Investment?

 

Investors who are looking for greater diversification and the potential for a steady stream of income may consider adding multifamily real estate to their portfolios. While many different property types are available to investors, multifamily properties have remained a consistently popular asset class for years.

Often referred to as “Apartments,” multifamily assets may be an attractive option for investors seeking an alternative source of income beyond traditional fixed income securities. In addition, privately-owned multifamily properties generally have a lower correlation to publicly traded securities, which can help diversify an investment portfolio and potentially reduce volatility. These characteristics often make multifamily properties an appealing option for 1031 exchangers seeking a replacement property. 

What is a Multifamily Investment Property? 

As the name suggests, multifamily properties house multiple families in a single location. Technically, any residential property that contains more than one rental unit (each with its own kitchen and bathroom) is considered a multifamily property. Whether the units are located side-by-side or stacked within the same building is true.

The most common type of multifamily investment property is the apartment complex, which the industry generally recognizes as one of three types – garden style, mid-rise, or high-rise.

Are Multifamily Properties a Smart Investment? 

Recent studies show that 36% of U.S. households currently rent their homes. Overall, homeownership is on a downward slide. The recent sharp uptick in home prices has impacted a whopping 39% of potential would-be homebuyers who earn more than $50,000 annually by pricing many of them out of the housing market.*

In addition, a greater number of higher-income Millennials are choosing “lifestyle renting.” This phenomenon refers to a preference for the flexibility and amenities of upscale rental units over the desire for homeownership. The allure of an all-inclusive location with all of the amenities you could want to be located in your apartment building is quite enticing when considering where you would like to live and what you’re willing to spend. The demand for rental units is further fueled by retiring baby boomers, many of whom are selling their homes and moving into adult-only multifamily housing.* These housing developments work well for the outdoor maintenance-free requirements with the camaraderie and lifestyle amenities to entertain a retired renter.

Potential Challenges of Multifamily Investing 

While multifamily properties may provide investors with an alternative source of income and the potential for appreciation, the task of actively managing these properties may be too burdensome for many.

In addition, large multifamily properties generally carry a high price tag, and the large upfront investment may put them out of reach for most investors.  The good news is that another strategy is available to investors who want to own multifamily properties. If suitable, one can add multifamily properties to their portfolio by investing in alternative investments such as a Delaware Statutory Trust (DST). The DST is a passive investment option that typically requires a much lower minimum investment because investors own a fractional interest in the property and other investors. DSTs allowed investors to own institutional quality multifamily assets, completely managed and operated by professional companies.

A DST that holds multifamily properties provides all the benefits discussed above without the hassle of active management. A DST also can provide significant opportunities for diversification because it can hold different types of multifamily in multiple locations.

1031 Exchange into a Multifamily DST

If you are an accredited investor who currently owns an investment property and is ready to replace it with a multifamily investment, a 1031 DST may be a viable option. This allows you to access all the potential benefits of a multifamily DST while also deferring your capital gains and depreciation recapture taxes.

Contact us today to learn more about this investment strategy.

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Source: Is Multifamily Real Estate a Good Investment?

https://www.creconsult.net/market-trends/is-multifamily-real-estate-a-good-investment/