What is a 1031 Exchange?

A 1031 Exchange is a transaction in which a taxpayer can sell one property and buy another without a tax consequence. This is generally done to avoid paying capital gains tax on the sale of appreciated property and/or property that has been substantially depreciated for tax purposes over a number of years, and therefore has a very low tax basis.

IRS Code Section 1031 allows a taxpayer to take up to 100% of the proceeds from the sale of property and purchase ownership in new property, while deferring the tax on the capital gain.

Section 1031 of the Internal Revenue Code provides an effective strategy for deferring the capital gains tax that may arise from the sale of your business/investment property.

By exchanging the property for like-kind real estate, property owners may defer their tax and use all of the sale proceeds for the purchase of replacement property.

Like-kind real estate includes business/ investment property, but excludes any personal use property. Section 1031 of the Internal Revenue Code provides an effective strategy for deferring the capital gains tax that may arise from the sale of your business/investment property.

By exchanging the property for like-kind real estate, property owners may defer their tax and use all of the sale proceeds for the purchase of replacement property.

Like-kind real estate includes business/ investment property, but excludes any personal use property.

How the exchange works: the basics

Seller arranges for the sale of property and includes exchange language in the sale contract.
At closing, sale proceeds are deposited with a Qualified Intermediary" (QI) or escrow agent.
Seller identifies potential replacement property within 45 days.
Seller completes purchase of replacement property within 180 days by directing QI to release funds for closing.

Basic Requirements

For complete tax deferral, investors must:

Reinvest 100% of net sales proceeds into the replacement property;
Acquire an equal or greater amount of debt on the replacement property;
Identify potential replacement property within 45 days from the date of sale;
Close on the replacement property within 180 days from the date of sale1;
Use a Qualified Intermediary (QI)
Together with your QI, Bravest Wealth will help you determine which Identification Rule to follow >>

Identification Rules

Three Property Rule: The taxpayer may identify up to three properties of any fair market value and purchase any (or all) of them, regardless of total value. This is the most commonly used identification rule.

200% Rule: The taxpayer may identify an unlimited number of properties provided the total fair market value of all properties identified does not exceed 200% of the fair market value of the relinquished property and may purchase as any (or all) of the identified properties.

95% Rule: If the taxpayer identifies properties in excess of both of the above rules, then the taxpayer must acquire 95% of the value of all properties identified.

Potential Benefits of a 1031 Exchange

Tax Deferral: A properly executed 1031 Exchange may allow investors to defer State and Federal income taxation upon the sale of appreciated real estate, thereby preserving equity and potentially maximizing total return.

Ongoing Tax Benefits: A portion of monthly income may be offset by depreciation.

Increased Cash Flow: Investors seeking more current income can benefit from a 1031 Exchange from non-income producing or under-performing assets into one or more high-quality properties that may generate monthly income.

Capital Appreciation: Growth in the overall value of real estate holdings is necessary to overcome the effects of inflation. A 1031 Exchange may provide investors the opportunity to allocate their capital into assets that may increase the potential for appreciation.

Diversification: A 1031 Exchange can be a powerful tool to realize investment diversification, which may be achieved by: diversification in geographic region (multiple properties in multiple states); asset class (office, industrial, retail, multifamily); tenant industry and creditworthiness; capitalization structure (debt vs. equity); and/or ownership structure (fee simple vs. leasehold and severalty vs. co-ownership)

Fractional Interest as Your Replacement

Section 1031 Exchanges have been part of the tax code since 1921. In 1995 the IRS began allowing for replacement properties to have multiple owners. This meant that a taxpayer no longer had to find and buy property on their own. The IRS rules provide that you can purchase/exchange into a partial interest of professionally managed real estate. Today that is usually accomplished through a Delaware Statutory Trust (DST).

What is a DST?

A Delaware Statutory Trust (DST) is a legal entity created under the laws of the State of Delaware. A DST is a trust that acquires real estate to be used as 1031 replacement property. Each taxpayer who exchanges into the DST becomes a "beneficial owner" of the Trust. Each owner's beneficial interest is based on the amount they exchange/contribute to the Trust. All income, expenses, appreciation, debt reduction, etc. is shared based on the owner's percent of interest in the Trust.

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Potential Advantages of a 1031 Exchange via a DST

Tax Deferral: A properly executed 1031 Exchange may allow investors to defer State and Federal income taxation upon the sale of appreciated real estate, thereby preserving equity and potentially maximizing total return.

Passive Investment: One of the positive attributes of a 1031 Exchange for many investors is the ability to relinquish their ongoing property management responsibilities while still maintaining the potential for stable, monthly income from investment real estate.

Institutional Quality: Fractionalized real estate investments, structured as a Delaware Statutory Trust (DST), may offer investors the opportunity to own a partial interest in a higher quality asset than they could obtain individually. For example, investors may execute a 1031 Exchange from raw land or residential rentals into large, Class A properties with credit tenants, professional management, and better long-term appreciation potential.

Pre-Arranged Financing: With ongoing challenges in the global credit markets, individuals often find it difficult to obtain favorable financing on their own. Professional 1031 Exchange Sponsors can remove this stress by pre-arranging favorable loan terms. Investors then receive their allocated portion of any such financing.

Income Stream: Designed to provide a potential steady monthly income stream.* This income can be counted on by surviving family members (Spouses and children) without the worry of property management

Diversification: A 1031 Exchange can be a powerful tool to realize investment diversification, which may be achieved by: diversification in geographic region (multiple properties in multiple states); asset class (office, industrial, retail, multifamily); tenant industry and creditworthiness; capitalization structure (debt vs. equity); ownership structure (fee simple vs. leasehold and severalty vs. co-ownership), anticipated holding periods, management firms, and more.

Tax Shelter: DST allows for the continued use of depreciation to tax shelter the income created. In addition, some DST properties are in states that have no state income taxes, like Florida or Texas, providing even more tax savings. This maintains, and in some cases, helps to improve, your tax sheltering ability.

Nonrecourse Loans: Eliminates personal guarantees by utilizing nonrecourse loans

Estate Planning Tool: Allows for passing the appreciated asset to beneficiaries, using "stepped up basis", thus avoiding the payment of capital gains tax forever

Who Creates the DST?

Today there are several national managers (Sponsors) of property that create DST’s for use in a 1031 Exchange. These firms professionally manage billions of dollars of real estate. Investors in a DST are utilizing their expertise in management, tenant relationships, acquisitions, dispositions, leasing, financing, geographic knowledge, and industry research. Bravest Wealth Management works with you in selecting a suitable firm and property to use for your 1031 exchange.

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*Potential cash flow, returns and appreciation are not guaranteed and can be lower than expected.

There are material risks associated with investing in DST properties and real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal. Past performance is not a guarantee of future results. Potential cash flow, returns and appreciation are not guaranteed. IRC Section 1031 is a complex tax concept; consult your legal or tax professional regarding the specifics of your particular situation. This is not a solicitation or an offer to sell any securities. DST 1031 properties are only available to accredited investors (typically have a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last three years) and accredited entities only. If you are unsure if you are an accredited investor and/or an accredited entity please verify with your CPA and Attorney.

1031 Exchanges