Investors in the real estate industry are versed with such legal provisions as “1031 Exchange Properties.” With the 1031 exchange options, you could preserve your real estate value while changing property profits. We’ll consider the different forms of 1031 exchange properties you’d make as a real estate investor. You’d also see the advantages of each option and how you could become a beneficiary.
What the Term 1031 Exchange Means
A 1031 Exchange is an interchange of one investment property with another, allowing the investor to defer capital gains. Such deferrable taxes include capital gains tax, federal and state capital gains tax, and depreciation capture. Although the investor makes a profit on the exchange, they’d avoid tax until they’re selling for cash.
The term, which stems from the IRS code Section 1031, is also called a like-kind exchange. We don’t want to bore you with all the technicalities of the code. But one of the 1031 replacement property rules you need to be conversant with is the “like-kind” rule.
The regulation means that you can only exchange property the IRS considers like-kind to them. For instance, you could swap a ranch for a mall or a store for a farm. There’s usually no limit to how frequently you could do a 1031 exchange.
Delaware Statutory Trusts (DST’s)
A Delaware Statutory Trust is a legal entity that’s meant to hold a title to investments. These real estate investments could either be singular or multiple units of properties. See it as owning a fraction of a more extensive investment portfolio of numerous commercial companies. Additionally, an investor might hold DST’s in different property types, like self-storage REITS or geriatrics housing.
DSTs are a passive income stream to investors—one reason why several real estate investors prefer them. Instead of wading through onerous national rent regulations, investors would rather have something less burdensome.
Isn’t it? Imagine managing issues such as rent control amid a lingering pandemic. Not all landlords have the patience to go through such stress. It’s therefore understandable why any real estate investor would choose the DST option.
Delaware Statutory Trust “Sponsors”
Different fields have their different terminologies—and so does real estate. To decode the term DST “sponsor,” replace the “sponsor” with the word “manager.” And there you have it. DST sponsors are those who manage a DST investment on behalf of the property owners. The manager, or sponsor, is in charge of acquiring the real estate and deciding its day-to-day affairs.
The DST sponsor also secures long-term financial and tax reporting of the investment to the government. Ultimately, the trust’s sponsor decides when or how they’d sell the property off to another investor.
Delaware Statutory Trusts in Summary
- Relatively low minimum investment provision of $100,000 for 1031 exchanges
- Passive investment. DST lets the investor sit back while a sponsor-affiliated trustee handles the management of the property(s).
- Diversifiable Portfolio. DST Investors don’t have to put all their funds in one property. DSTs let you diversify your investment across geographical regions and different property types.
- Protection from any liability. When a 1031 Exchanger chooses a DST investment, they’re protected from any liabilities concerning the shielded property.
Fee Simple Property
Free Simple properties mean that you have outright ownership of the investment property. It’s an avenue for you to own and control your property. Fee Simple Property includes any 1031 exchange of rental property into a vacation home or residence.
Any fee simple 1031 Exchanger has the right to do whatever they wish with the property. This set of investors have the most expansive property rights to their facilities. Once they hold the property titles, no one would penalize them for tampering with it. If you wished it, you could tear down the entire structure and build another. You’re free to extend, renovate, and even will the total 1031 exchange properties as an inheritance.
Absolute Fee Simple and Fee Simple Defeasible Properties
Fee Simple Properties come in two basic types. They could either be absolute or defeasible fee simple investments. Absolute fee simple ownership also called “freehold,” refers to total ownership of the property.
The absolute fee simple owner is permitted to do whatever they wished on the land. They only need to ensure that they obey local and zoning laws and possible liens. Investors won’t have any clashes with the government or individuals as long as they’re law-abiding.
On the other hand, fee simple defeasible ownership means full ownership under certain predefined conditions. These terms are put in place by the former owner of the property. Such conditions might indicate that the new owner shall not use the property for commercial reasons. If the current investor violates them, it could result in them losing the property.
Regardless of whether they have an absolute or defeasible property, the investor is bound by the law. You’d do well to note all zoning laws and municipal regulations in your property’s location.
Tenants-In-Common Property
Tenants-in-common properties are a more flexible alternative to DST’s. Just like with DSTs, TIC properties let 1031 exchangers buy a percentage interest of a larger property. However, they’d share units of a shared property with “co-tenants.”
Tenancy-in-Common agreements, two or more “tenants” co-own a real estate property, either commercial or residential. A tenant-in-common has the right to bequeath their share of the property to any beneficiary. They can also place part or all of their 1031 exchange properties for sale.
Here’s How TIC works
In a TIC, all tenants in common equally own all areas of the property. That is, no singular tenant could lay claim to any part of the property. However, the co-tenants have their percentage share of the entire property. For instance, Jack, Jane, and Brown could own 30% while Jane and Brown each own 35%.
At any point in time, either of the three could voluntarily relinquish their share to any beneficiary. And where one tenant-in-common no longer wishes, one partner could sell their percentage to another partner. So, from our last example, Brown may choose to sell out their rights to another partner. The partnership would then become a 65%-35% TIC split. Note that, before any 1031 exchange is completed, the taxpayer issues a 1031 replacement property identification form. This form would identify that the property isn’t under any escrow or contract.
In a Nutshell
Investors prefer 1031 exchange properties because of the tax-deferment benefits that the exchange offers. Do you own an investment property and are considering selling it off to purchase another property? You’d do well to be aware of the various 1031 exchange provisions to benefit from them possibly.
