In this article:
- What is a 1031 Exchange?
- Advantages of 1031 Exchanges
- Legal Structures for 1031 Exchanges
- DST vs. TIC Comparison
- Navigating 1031 Exchanges in 2024
What is a 1031 Exchange?
A 1031 exchange, also known as a like-kind exchange, is a powerful tax-deferral strategy allowing real estate investors to defer paying capital gains taxes when they reinvest proceeds from the sale of a property into a new, similar property. Named after Section 1031 of the IRS tax code, this provision encourages investment by offering significant tax benefits.
Key Steps in a 1031 Exchange:
- Sale of Property: Sell an investment property.
- Use of Qualified Intermediary: Place proceeds with a Qualified Intermediary.
- Identification of Replacement Property: Within 45 days, identify up to three potential replacement properties.
- Acquisition of Replacement Property: Complete the purchase of the new property within 180 days using the sale proceeds.
Criteria for Like-Kind Property:
- Must be used for business or investment purposes.
- Must be located within the United States.
- Must be of the same nature, character, or class as the relinquished property.
Advantages of 1031 Exchanges
The primary benefit of a 1031 exchange is the deferral of capital gains tax, allowing investors to reinvest the full sale proceeds into new properties. This can lead to portfolio growth and enhanced investment returns. Other benefits include:
Upgrading Assets: Transition from underperforming properties to more lucrative investments. Diversification: Spread risk by investing in a variety of properties. Legacy Wealth: Defer taxes indefinitely and pass properties to heirs with potentially minimized tax burdens.
Legal Structures for 1031 Exchanges
1031 exchanges can be facilitated through collective investment structures, enabling multiple investors to participate in large-scale real estate projects. The two primary structures are Delaware Statutory Trusts (DSTs) and Tenants in Common (TIC).
Delaware Statutory Trusts (DSTs)
A DST is a legal entity that allows multiple investors to co-own property while limiting personal liability. It functions similarly to an LLC but is specifically designed for real estate investments.
Key Features of DSTs:
- Pass-Through Taxation: Profits and losses are passed through to individual investors.
- Fractional Ownership: Enables investment in large properties with lower capital requirements.
- 1031 Exchange Eligibility: Interests in a DST can qualify as replacement property in a 1031 exchange.
How DSTs Operate
A lead investor, or sponsor, acquires the property and offers beneficial interests to passive investors. This structure allows individuals to invest in high-value commercial real estate, such as multifamily units, office buildings, and mixed-use properties, at a lower entry cost.
Tenants in Common (TIC)
TIC is another legal structure for fractional ownership in real estate. While similar to DSTs, TIC has distinct characteristics:
Key Features of TIC:
- Investor Limit: Limited to 35 investors, often resulting in higher minimum investments.
- Liability Protection: Requires single-member LLCs for personal liability protection.
- Voting Rights: Decisions require unanimous consent, which can be cumbersome.
DST vs. TIC Comparison
DSTs are generally preferred for 1031 exchanges due to their passive nature, ease of execution, and lower barriers to entry. TIC arrangements, while viable, often involve more complex management and higher investment thresholds.
Navigating 1031 Exchanges in 2024
For self-directed real estate investors, accessing 1031 exchange opportunities requires careful planning and partnering with knowledgeable platforms. The Stream Group offers accredited investors access to private-market commercial real estate investments, including 1031 exchange opportunities.
Key Considerations:
- Planning: Ensure timely identification and acquisition of replacement properties.
- Partnership: Work with experienced platforms to navigate legal and financial complexities.
For more information on 1031 exchange opportunities with The Stream Group, contact our Investor Relations Team.
About the Author
Timothy Shaw
Timothy Shaw is a Founding Partner at The Stream Group. Leveraging his broad experience in real estate, he provides strategic guidance and advisory support. His background includes multifamily syndications, distressed asset acquisition, and serving as a licensed real estate salesperson in Ohio. At The Stream Group, Tim focuses on ownership and investment strategies, ensuring the firm’s long-term growth and vision.
Before his real estate career, Tim served as a lieutenant in the fire department. His career in public safety allowed him the opportunity to serve in many roles, including firefighter, flight paramedic, hazardous materials technician, and certified fire safety inspector. This background instilled a deep commitment to service and integrity, values he brings to his work with investors, tenants, and team members.
A graduate of the University of Cincinnati with a degree in Fire Science Engineering, Tim is dedicated to creating an environment where systems and data drive success. He admires Warren Buffett’s investment philosophy: “When others are greedy be scared, when others are scared be greedy.”
Tim is married with two children and enjoys traveling with his wife. They spend their free time at their second home on Amelia Island.