Updated: Apr 11
In 1998, I began my career as a mutual fund operation analyst with one of the largest financial investment firms on Wall Street. Then, I passed Registered Representative, Registered Options Principal, Registered Principal Commodity, Registered General Securities Principal, and Insurance Licenses Exams. I earned my MBA in Finance after that. I worked as a financial advisor for decades before owning my Registered Investment Advisor firm. I am invariably curious about investment opportunities and financial risk trade-offs. I just enjoy studying various investment research. In recent years, I analyzed the 1031 options as clients came to my firm and asked me for additional information besides stocks or bonds to create a diversified portfolio.
Knowledge is never enough or perfect. So, I met up with DST brokerages, DST sponsors, and TIC investment firms and reviewed the different types of private addendum properties as part of my due diligence investigations. I also paid advice from a CPA, a Real Estate attorney, a Commerical and residential real estate broker, and an Estate Planning attorney. In this article, I am educating my readers on the high-level understanding of 1031 exchange and sharing my interpretation of Delaware Statutory Trust (DST) properties, Tenant in Common (TIC) properties, and residential and commercial Real Estate as tax-deferred replacement properties.
As a disclosure, I discovered there is no perfect real estate investment, and each option has its advantages and disadvantages for different individual goals and time horizons. Furthermore, real estate is subject to market cycles, and an investor can be subject to loss of principal, occupancy rate, liquidity, and other management issues. After reading my article, I hope you only decide on investment suitability behind a thorough financial and risk assessment with a qualified investment advisor, CPA, and Real Estate professional or attorney.
Below are the sections we will go over.
What are 1031 exchanges?
Who do you use for the compliance process with the 1031 exchange?
What are the reasons for doing a 1031 exchange?
What are DST properties?
What is TIC ownership?
1. What are 1031 exchanges?
Here is the direct definition from the IRS website: "Like-kind exchanges -- when you exchange real property used for business or held as an investment solely for other business or investment property that is the same type or "like-kind" -- have long been permitted under the Internal Revenue Code. Generally, if you make a like-kind exchange, you are not required to recognize a gain or loss under Internal Revenue Code Section 1031. If, as part of the exchange, you also receive other (not like-kind) property or money, you must recognize a gain to the extent of the other property and money received, and you can't recognize a loss."
For example, you can defer capital gains if you sell an investment or rental property and use the proceeds to buy another similar property. However, like-kind properties should have equal or greater value and mortgage debt. The timeframe to qualify for the exchange is that investors must identify a specific potential replacement property or properties within 45 days of closing. However, the replacement property or properties must be closed within 180 days of completing the relinquished properties.
2. Who do you use for the compliance process with the 1031 exchange?
Only use a Qualified Intermediary (QI) as a facilitator to handle the exchange trial process. Refrain from saving money by only using Escrow agents to hold the proceeds from the sale of the relinquished property before purchasing a new property. The typical charge for a QI is around $1000 per property, and the IRS requirement states that the QI should handle instructions to the settlement agent and the documentation process. An experienced Realtor should be able to recommend you a QI for 1031 transactions. If a realtor did not bring in a QI when you mentioned 1031 sales, you might need to find a realtor with experience in 1031 exchanges.
3. What are the reasons for doing a 1031 exchange?
Without a 1031 exchange, a sale of an investment property could be subject to capital gains tax, depreciation recapture, and medicare surtax. 1031 exchange allows investors to claim tax deferral.
Investors want to exchange one property for another to improve their income stream, reduction of risk, inflation protection, and long-term estate planning.
An investor wants to maintain a diversified income and growth portfolio in real estate besides having investments in cash or the stock market.
An investor wants to leverage the returns from one real estate property with a better return opportunity by reinvesting the proceeds.
4. What are DST properties?
DST (Delaware Statutory Trust) is a form of fractional ownership that can be a way to make a passive investment in real estate without the headache of managing tenants, the toilets, or the county inspector. A DST sponsor is the institutional investor who will acquire and package the properties and offers a percentage of ownership to accredited investors. The DST sponsor is responsible for property management. The most common DST commercial properties are medical offices, shopping centers, hotels, warehouses, public storage, apartments building, and even University housing. Investors will maintain a portion of the depreciation and income according to the ownership percentage. Typically, DST only accepts accredited investors certificated by a family attorney or certified public accountants with liquidated assets over $ 1 million, total assets over $2 million, and annual income over 200,000 for individuals or $300,000 as couples in the last two years.
5. What is TIC ownership?
TIC is Tenant in Common ownership. It is a form of undivided fractional interest to make passive real estate investments, and investors qualify for a pro-rata portion of the appreciation. The minimum investment amount varies from $100k to $500K. Like DST, it is another type of ownership that allows the investor to transition from actively managed to passive management responsibilities. It will enable both accredited and nonaccredited investors' qualifications. It can be any commercial property, and most TIC managers might use their property management team vs. hiring an outside property management firm.
Below is a comparison table I create to explain between DST, TIC, and Rental properties:
Realtors can assist clients in finding the right property, but their experience is not in running Cost–benefit analysis and Cash-flow risk and return assumptions. Nevertheless, finding an investment professional with a multi-level understanding of securities, and risk management, with tax and real estate expertise, can help offset the potential issues in challenging market conditions.
DSTs, TICs, or traditional residential properties can offer attractive profits. However, I prefer debt-free DST or TIC properties even if the investment return is lower than leverage debt financing properties. I can't agree with signing up for a high-interest-rate loan to invest in real estate in this current economic environment. I must remind my readers that the possibility to refinance later is a gambling mindset because one assumes the value of investment properties must not go down for qualification of refinancing. No one can accurately time the market, and an investment philosophy should be long-term. Therefore, I would rather deny an attractive return with borrowing options in exchange for safety with limited risk for my clients.
Secondly, DST and TIC properties are illiquid. It is subject to higher regulatory requirements, which is nice. However, I don't particularly appreciate that TIC doesn't allow a Living Trust registry. Depending on the stage of your life, some questions to consider are: What is important to you? Is it the freedom to enjoy time and peace or maintain an active role in managing your properties? Is it worth giving up decisions and control with communications to suppliers, contractors, and tenants? What is the liability and return of managing your residential properties? What are the cost of insurance and the cost of property management personnel? Finally, what are the identified options or opportunities presented to you as replacement properties?
Real estate can be a volatile investment class. An investor can be subject to loss of principal, so I urge my reader to research and seek professional guidance before entering or exiting a real estate investment.
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