Considering a 1031 Exchange? What You Need To Know For Taxes In 2024 

Property ownership has historically proven to be a solid strategy for wealth accumulation and financial stability. When managed effectively, it can offer the potential for a dependable income stream with minimal oversight requirements. However, to meet their investment goals, many investors find it necessary to recalibrate their property portfolios periodically.

The prospect of trading an existing property for one that aligns better with an investor's strategic objectives is appealing until you factor in the significant tax liability triggered by the sale. It's worth noting that the tax imposed on sale proceeds can reach up to 42.1% at the Federal level, in addition to any state income tax, if applicable.

However, a well-planned 1031 Exchange can provide a way out of this taxing predicament. This provision allows investors to divest from a property without the burden of capital gains tax or depreciation recapture tax, provided the sale proceeds are funneled back into "like-kind" investment real estate of an equal or higher value and that all IRS tax code stipulations are duly observed.

Seven Potential Benefits of a 1031 Exchange Beyond the Scope of Tax Deferral

While tax deferral is undeniably a prime attraction of a 1031 Exchange, it's not the sole potential benefit enticing property investors. This tax provision may also act as a strategic tool to "level up" your real estate investment portfolio, enabling you to strive to achieve your specific objectives.

This could mean acquiring larger properties, procuring assets in more desirable locations, investing in newer builds, potentially generating higher income, striving to mitigate risks, or attempting to meet any other personal investment milestones. Here are seven distinct ways a 1031 Exchange can be used to seek to elevate the value of your single-property investment portfolio:

 1. Transition to a potentially more advantageous property type.

The flexibility of a 1031 Exchange permits investors to diversify their portfolio across an array of property types, even extending to different ownership structures such as fractional ownership of large, income-yielding "institutional" real estate.

This could be a prudent decision if, for instance, an investor with a retail property is facing hurdles due to the surge in e-commerce and may prefer investing in residential buildings in areas with robust population growth. Similarly, a retiree seeking steady income may decide to exchange a multifamily property focused on appreciation for a different property type that yields higher cash flow.

2. Relocate your investment to a more desirable location.

The geographical location of a rental property can profoundly affect its value, cash flow, and potential for appreciation. A 1031 Exchange offers the opportunity to reinvest in properties located in areas offering more favorable conditions, such as states with lower taxes, rapidly growing markets, or more advantageous landlord-tenant laws.

3. Augment the capital re-invested in the next property.

By using a 1031 Exchange, investors can reinvest the entire net proceeds from the sale of their relinquished property into a new one. This tax deferral can be regarded as an interest-free loan from the government, enabling a more substantial investment in the next property, thus potentially leading to increased cash flow and appreciation.

4. Enhance monthly income potential and possible returns.

A 1031 Exchange may serve as a powerful instrument for wealth accumulation, allowing investors to leverage the appreciated value of their property to expand their purchasing power without any tax consequences. With this enhanced buying power, investors are able to target properties with a focus on delivering not only higher but also passive income potential.

Moreover, retaining the full net proceeds from the sale facilitates the acquisition of higher-value properties. The potential to defer capital gains tax across a lifetime of real estate transactions creates a systematic path for personal wealth creation and subsequent transfer to heirs.

5. Strive to diminish the risk on the capital reinvested into real estate.

Given the high entry costs associated with real estate investing, investors often allocate a substantial portion of their net worth to one or two properties, typically within the same locality and of the same property type. Exchanging into a Delaware Statutory Trust (DST) real estate through a 1031 Exchange allows investors to spread their capital across multiple DST properties, thereby diversifying their portfolio across various property types and geographic locations.

6. Lighten tax burdens and complexities for estate beneficiaries.

Employing 1031 Exchanges to defer tax liabilities until an owner's passing can eradicate these deferred taxes for their beneficiaries, thereby amplifying the inherited value for future generations. Upon the owner's passing, the IRS wipes clean capital gains, depreciation recapture, and net investment income tax, a process known as "step-up in basis."

In "community property" states, a surviving spouse is entitled to a full step-up in basis to the fair market value of the properties. This means that the property could be sold immediately after receiving the step-up without incurring any of the aforementioned taxes.

7. Leverage the Power of Passive Investing: Simplifying Property Management with a 1031 Exchange

For seasoned real estate investors seeking to streamline their investment endeavors, the 1031 Exchange offers a golden opportunity. By utilizing this powerful tax strategy, investors can effectively reduce the time and effort spent on property management. Instead, they can seamlessly transition into passive investment options, such as top-tier DST real estate offerings curated by experienced institutional management teams. Experience the benefits of hassle-free ownership while seeking to increase your returns through the 1031 Exchange.

Navigating the Risks: Examining the Downsides of a 1031 Exchange

Yellow paper boat with a compass illustrating the new direction and challenges when navigating the risks and benefits of a 1031 exchange for tax deferral

Before diving into a 1031 Exchange, it's crucial to acknowledge the risks involved in this investment strategy. Real estate, being an illiquid asset class, requires careful evaluation to ensure its suitability for an investor's financial position and objectives. Liquidity emerges as a significant consideration, as investors need to possess sufficient liquid assets to cover unforeseen expenses, such as medical bills. However, there are mitigation strategies available, such as exploring refinancing options or acquiring suitable insurance coverage.

One notable drawback of a 1031 Exchange lies in its inherent complexity. Mishandling the process can result in substantial costs. Hence, it becomes imperative to collaborate with trustworthy 1031 Exchange companies, qualified intermediaries, proficient tax counsel, as well as experienced financial professionals and estate planning attorneys. At Perch Wealth, we prioritize working alongside our clients and their advisors, ensuring a comprehensive understanding of exchange regulations, thorough discussions on associated risks, and flawless execution of the transaction.

Determining the Suitability of a Tax-Deferred 1031 Exchange for Your Needs

Portrait of a female financial consultant advising on the suitability of a tax deferred 1031 exchange for ensuring financial stability

The utilization of a 1031 Exchange as a tax strategy has gained significant traction among investors when selling investment properties. IRS data reveals that over the course of ten years, from 2004 to 2013, a staggering $1.3 trillion worth of properties exchanged hands in more than 2.9 million transactions. The popularity of 1031 Exchanges tends to surge during robust economic periods, as property owners seize the opportunity to leverage the appreciating real estate market.

For real estate investors seeking a flexible solution that aligns with their financial and lifestyle objectives, tax-deferred exchanges offer an attractive proposition. Whether the goal is to reduce active management, enhance income, or minimize taxes for beneficiaries, the versatility of a 1031 Exchange can serve as a valuable tool for attempting to achieve successful real estate investments.

At our firm, we prioritize empowering investors with a comprehensive understanding of the benefits and risks associated with 1031 Exchange options, various locations, market conditions, and how these factors can be synergistically combined to achieve their investment goals.

If you are considering selling your investment property and wish to explore 1031 Exchange options further, we encourage you to reach out to us and speak with one of our licensed 1031 Exchange professionals. We offer complimentary consultations that can be conducted over the phone, via video conference, or in person at one of our offices.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing. Any information provided is for informational purposes only.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication. 

1031 Risk Disclosure: 

Cracking the Code: Can You Use a Loan in a 1031 Exchange?

Leveraging the Tax Code: Exploring Loans in a 1031 Exchange

Section 1031 of the U.S. Code offers a golden opportunity for capital gains tax deferrals on specific real estate sales. As part of the exchange process, you must acquire a property of equal or higher value than the one you're relinquishing.

However, there may arise instances where the proceeds from your relinquished property are either insufficient or not immediately accessible to fund the acquisition of the replacement property. In such situations, securing a loan could be a viable solution to successfully complete the exchange.

Bridging the Gap: Exploring Bridge Loans in a Like-Kind Exchange

In a like-kind exchange, it is important to remember that your replacement property should be of equal or greater value compared to your relinquished asset. However, acquiring a property of greater value may result in a capital gap between the proceeds from the sale of your relinquished property and the funds required to fully finance the purchase of the replacement property.

To navigate this situation, a bridge loan can come to the rescue. Bridge loans offer short-term and expedited financing solutions. They serve as an interim financing option until you can either refinance into a long-term loan or pay it off entirely, providing you with the necessary funds to bridge the gap during the exchange process.

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Exploring the Reverse Exchange: Acquiring the Replacement Property First

The most common approach to a like-kind exchange is the delayed exchange, where you sell your relinquished property and subsequently acquire the replacement property within the designated IRS deadlines.

Alternatively, there is the reverse exchange, which allows you to acquire the replacement property before selling the relinquished property. However, in this scenario, you cannot hold both properties simultaneously. To navigate this situation, an Exchange Accommodation Titleholder (EAT) is employed to take temporary possession of either the replacement or relinquished property.

In some cases, you may require a loan to finance the acquisition of the replacement property, as you have yet to receive proceeds from the sale of your relinquished property. Upon selling the relinquished property, you can immediately repay the loan. It is important to note that this type of financing is highly specialized and typically offered by select lenders or financial institutions for short-term purposes.

Proceed with Caution

If you find yourself considering the use of a loan in the situations mentioned earlier, it is vital to exercise utmost caution and carefully select a lender who possesses significant experience and knowledge in handling like-kind exchanges. The intricate nature of a 1031 exchange means that even a minor misstep or confusion during the loan process could raise red flags and potentially expose you to unexpected tax liabilities.

It is worth noting that paying off debt on the relinquished property within the exchange timeframe can trigger adverse tax consequences as well. Therefore, it is crucial to approach the inclusion of debt in your 1031 exchange process with meticulous care and thorough planning.

To mitigate the risks associated with loans in a 1031 exchange, it is highly advisable to seek the guidance of a qualified tax or financial professional. These experts can provide invaluable insights, ensuring that you fully comprehend the potential tax implications and navigate the process prudently.

By working closely with professionals who specialize in 1031 exchanges and diligently considering the implications of incorporating debt, you can safeguard yourself against unnecessary financial burdens and successfully execute a tax-efficient exchange.

Remember, in the realm of 1031 exchanges, knowledge is power, and partnering with knowledgeable professionals will help you make informed decisions that align with your financial goals and minimize any potential tax liabilities that may arise from utilizing loans in your exchange.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing. Any information provided is for informational purposes only.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

1031 Risk Disclosure:

Exploring the Two Types of Boot in a 1031 Exchange

For many years, real estate investors have utilized 1031 exchanges as a means of delaying the payment of capital gains tax arising from the sale of investment properties. To achieve complete deferral of capital gains taxes on any profits realized, investors are required to reinvest the full sale proceeds from their relinquished assets. Funds that remain uninvested are categorized as "boot" and attract tax liabilities.

This article delves deeper into two types of boot, namely cash and mortgage boot, and explores how they are generated during a 1031 exchange.

Understanding the Generation of Cash/Equity Boot in a 1031 Exchange

For many investors, the primary objective of engaging in a 1031 exchange is to defer capital gains taxes that result from the sale of investment properties. However, receiving cash from the sale and reinvesting less than the full sale proceeds into the replacement asset can generate a taxable event. For example, if an investor reinvests only $900,000 of a $1 million sale, the remaining $100,000 would be considered cash boot and subject to capital gains tax liability.

The amount of tax liability depends on the investor's income and tax filing status. If the investor is in the 0% tax bracket, there is no tax liability, but if they are in the 15% or 20% bracket, the tax liability on a $100,000 cash boot would be $15,000 or $20,000, respectively.

In addition, if the investor held the asset for a short-term period, the tax liability could be even higher, as short-term capital gains are taxed as ordinary income at the investor's marginal tax rate, which could be up to 37%.

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Understanding the Impact of Receiving Cash Boot in a 1031 Exchange: How Tax Liabilities are Determined and the Consequences of Taking Cash Out.

If an investor does take cash out of a 1031 exchange, they can replace it with cash boot paid during the closing on the replacement asset. However, any net cash boot received will always generate a taxable event. It's important for investors to carefully consider the tax implications of taking cash out of a 1031 exchange and to consult with a tax professional to fully understand the potential consequences.

Exploring the Generation of Mortgage/Debt Boot in a 1031 Exchange

In a 1031 exchange, generating boot is not limited to taking cash proceeds out of the exchange. Mortgage boot, also known as debt boot, can be created if the debt on the replacement asset is less than the debt on the relinquished property.

For example, let's say you sold your relinquished asset for $1 million and had a mortgage of $250,000, which was paid off at the close of sale. You then rolled the entirety of the sale proceeds into a replacement asset, but the mortgage on your replacement property was only $200,000. This means that you generated $50,000 in mortgage boot, which is subject to capital gains tax.

To avoid taxation, exchangers who exchange properties with unequal mortgage debt can bring additional cash to the closing table. It's important to note that while you can use cash to offset mortgage debt, you cannot use additional debt to offset any cash taken from the exchange.

Unlike cash boot, mortgage boot doesn't generate an immediate tax liability. Instead, the tax liability arises when the replacement property is sold, and the mortgage boot is realized. It's important to remember that the tax liability on mortgage boot will be based on the capital gains tax rate applicable to the taxpayer's income and filing status at the time of the sale.

It's worth noting that mortgage boot can also be created if the replacement property has no mortgage, or if the mortgage on the replacement property is larger than the mortgage on the relinquished property. In either scenario, the difference between the mortgages would be considered mortgage boot, subject to capital gains tax.

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In summary, mortgage boot can be generated during a 1031 exchange when the debt on the replacement asset is less than the debt on the relinquished property. Exchangers can avoid taxation on mortgage boot by bringing additional cash to the closing table, and the tax liability on mortgage boot arises when the replacement property is sold.

Conclusion

In order to avoid generating mortgage or cash boot during a 1031 exchange, the entire sale proceeds from the relinquished property must be rolled over into a like-kind replacement asset, and an equal or greater amount of debt must be swapped. It's essential to avoid trading down, as this typically results in generating cash boot, debt reduction, or both, and may result in a taxable event.

If cash is taken out of the exchange, it's possible to supplement any reduction in mortgage debt during the closing on your replacement property by bringing additional cash to the table. Additionally, bringing cash to the closing table on the replacement asset can "square up" exchange funds.

To fully satisfy the equity and debt requirements on replacement properties and avoid generating cash or mortgage boot, it's recommended to consult with a Qualified Intermediary beforehand. This will help investors understand the exact amounts required to comply with exchange requirements.

In summary, investors must reinvest the entirety of the sale proceeds from their relinquished assets and swap an equal or greater amount of debt to avoid generating mortgage or cash boot during a 1031 exchange. They should also seek to trade up or straight across instead of down, and consult with a Qualified Intermediary to better understand exchange requirements and avoid taxable events.

 

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing. Any information provided is for informational purposes only.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

1031 Risk Disclosure:

 

Real Estate Syndication & DST 1031 Exchanges

Delaware Statutory Trust (DST) 1031 exchanges are becoming increasingly popular among investors due to the potential advantages of real estate syndication. Real estate syndication is a key aspect of the structure of DST 1031 investments and is a significant factor in their growing popularity as an alternative investment for accredited investors.

What Exactly Is Syndication?

Syndication refers to the process of bringing together a group of investors or organizations to collectively invest in an asset that requires a large amount of capital. In the context of real estate, it means organizing a group of investors to pool their financial resources to purchase one or more properties. Investors are issued beneficial interests or shares in the property, and profits and losses are distributed according to their percentage of ownership.

This concept is particularly relevant when discussing Delaware Statutory Trusts (DSTs) because they allow for multiple investors to own a property for their 1031 exchange or cash investment, unlike traditional 1031 exchanges which typically involve a single investor.

Additionally, DSTs can have a much higher number of investors (usually up to 499) compared to other group investment structures like Tenant in commons (TICs), which have a limit of 35 investors, making them a suitable option for those looking to invest in larger and more diverse real estate assets. However, unlike regular syndications, the DST property or properties have already been acquired by the DST sponsor before being offered to 1031 exchange investors.

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The Benefits of Syndication:

One of the major advantages of DST 1031 exchange investments for investors is that they eliminate the challenges and responsibilities of active ownership and management. In DST investments, the sponsor creates the trust and takes on the responsibilities of managing the assets and the business of the trust. These responsibilities can include:

-       Underwriting the Deal

-       Conducting due diligence on the property(ies)

-       Arranging financing

-       Creating a business plan for the property(ies)

-       Finding a property management company

-       Coordinating investor relations and potential monthly distribution checks to investors

-       Delaware Statutory Trust syndication provides investors with a passive ownership structure

In exchange for giving up active management, the passive investor of a DST 1031 property will typically receive 100% of their pro-rata portion of any potential principal pay-down from the loan on the property, thereby potentially building equity. In addition, DST 1031 properties are structured so that the investors in the DST receive 100% of their pro-rata portion of the potential rental income generated by the property's tenants.

Other Potential Benefits To DST Syndication:

Get ready to upgrade your real estate game, folks! With a syndicated Delaware Statutory Trust 1031 exchange, you'll have the chance to snag a piece of some seriously impressive, institutional grade assets.

We're talking industrial distribution centers, medical buildings, self-storage facilities, and even massive apartment communities worth $50 million or more! And the best part? With a typical minimum investment of $100,000, regular investors can get in on the action. It's like a VIP pass to a whole new level of real estate investing.

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Want to spread your investment wings? Then a Delaware Statutory Trust (DST) is just what you need! With a DST, you'll have the ability to invest in multiple properties, possibly mitigating your risk and increasing your chances of success.

Plus, you'll be able to choose from a variety of asset classes, like multifamily, commercial buildings, self-storage, medical facilities, and industrial distribution centers. And, with the ability to invest in multiple geographic locations, you'll be able to diversify your portfolio like a pro! And let's not forget, portfolio diversification is a tried and true economic theory, recognized by none other than Nobel-Prize winning economist Harry Markowitz.

Just remember, diversification does not guarantee profits or protection against losses and that investors should read each DST offerings Private Placement Memorandum (PPM) paying attention to the risk factors prior to considering a DST investment.

Investing in commercial real estate can be challenging, as it requires a significant amount of experience and resources. Even for experienced investors, it can be difficult to source, inspect, underwrite, and close on large institutional properties within the timeline of a 1031 exchange.

However, with a Delaware Statutory Trust (DST) syndication, investors can work with the specialized team at Perch Wealth, a national DST expert advisory firm. They have created a platform, www.perchwealth.com, that provides investors with access to a marketplace of DSTs from more than 25 different DST sponsor companies. Additionally, they have custom DSTs available only to their clients and provide independent information on DST sponsor companies as well as full due diligence and vetting on each DST investment.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing. Any information provided is for informational purposes only.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

1031 Risk Disclosure:

What to Know About 721 UPREITs in Relation to DSTs

One of the primary appeals of investing in commercial real estate is that it is a highly tax-advantaged asset class. There are many tools available for investors looking to defer paying capital gains tax upon the sale of real estate assets. The most well-known tool is the 1031 Exchange, which allows an investor to sell a property and roll the proceeds into another like-kind asset such as a building of greater value.

Another option is to roll the proceeds into a Delaware Statutory Trust, or DST, which is an entity used to hold title to investment property on behalf of individual owners, who each have a fractional ownership stake in the DST property.

However there is a third tool worth understanding, one that is often overlooked by investors. That tool is the Section 721 exchange into an UPREIT. Section 721 exchanges are often used in conjunction with DST investments, something we’ll explore in greater detail below.

What is a 721 UPREIT?

An Umbrella Partnership Real Estate Investment Trust, or UPREIT, is a unique structure that allows property owners to exchange their property for share ownership in the UPREIT. The share units will generally have the same value as the property that was contributed to the UPREIT. The UPREIT then owns the property and all administration associated with it.

UPREITs are regulated by Section 721 of the tax code and are often referred to as 721 Exchanges. Section 721 exchanges into an UPREIT do not create a taxable event. Therefore, UPREIT property contributors can defer paying taxes on the sale of property in exchange for UPREIT units, though capital gains taxes on UPREIT units will later be subject to standard REIT taxation.

Section 721 exchanges are different from 1031 exchanges, which require like-kind exchanges and so not allow for ownership exchanges of property. Therefore, while both 1031 exchanges and Section 721 exchanges into an UPREIT can be attractive, they should be used in different circumstances.

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How do UPREITs work?

In a typical UPREIT structure, all REIT properties are purchased and owned directly or indirectly by its “umbrella partnership” – sometimes referred to as the “operating partnership” or “OP”. The properties are operated and managed within the OP, of which the REIT acts as the sole general partner as well as a significant limited partner.

With a standard Section 721 exchange, an owner sells their property just as they would if selling for cash. However, instead of selling for cash, they sell their interest in the real estate to the UPREIT operating partnership. Since the OP entity is not considered an “investment company” for tax purposes, the contribution is not treated as a sale and capital gains may therefore be deferred.

The seller then receives OP Units instead of cash in exchange. With these transactions, the seller is also allocated a certain percentage (or dollar amount) of debt for the OP as well for tax purposes.

In practice, however, most REIT managers are not interested in the property individuals want to sell. Therefore, many Section 721 exchanges often occur through a two-step process involving a DST.

How to Utilize UPREITs as Part of a DST Transaction

Because most REITs do not want to purchase an individual’s property, most sellers will utilize a DST as a sort of “middle man” before utilizing a 721 Exchange.

Through this process, an owner sells their relinquished property and to the extent there are capital gains, those capital gains are reinvested into a DST using a 1031 exchange. The seller then retains an ownership stake in the DST.

Some DSTs exist with an UPREIT structure that allow investors to convert their DST ownership stake into shares of said UPREIT. Through the UPREIT option, investors can exchange their DST interests for OP Units in a REIT at the time the REIT exercises its option to purchase the DST property. These OP Units can later be converted into REIT common shares at the owner’s discretion.

The Pros and Cons of Utilizing UPREITs

There are many benefits associated with 721 UPREIT exchanges, including:

·      Tax Advantages: The 721 exchange allows investors to defer paying capital gains tax on appreciated real estate in exchange for shares of an operating partnership (“OP Units”). Capital gains continue to be deferred until the investor sells their OP Units, converts the OP Units to REIT shares, or the property contributed to the UPREIT is sold by the acquiring operating partnership.

·      Increased Liquidity: Real estate is generally considered an illiquid asset class. It cannot be purchased and sold with the click of a button, as is the case with stocks, bonds and other equities. However, transactions conducted through a 721 exchange allow investors to preserve liquidity by converting some or all of their OP Units into shares of the REIT, which can then be traded more easily (although doing so then creates a taxable event).

·      Portfolio Diversification: By selling individually-owned property and exchanging into an UPREIT, an investor benefits from greater portfolio diversification. REITs usually hold title to multiple assets, including different property types and in disperse geographies. Investing in a REIT is one way to mitigate risk rather than having all of one’s capital tied up in a single property.

·      Passive Income Potential: 721 Exchanges allow for investors to sell their property and essentially, hand off all property management obligations to the REIT operating partnership. This allows an individual to switch from being an active investor to passive investor. So long as they have taxable income, REITs are obligated to pay dividends to their shareholders and therefore, those who relinquish their individual property can continue potentially collecting passive income well into the future.

·      Estate Planning: One of the primary reasons people utilize 721 exchanges is for estate planning purposes. Upon death, REIT shares can be equally divided among heirs, who may elect to hold or liquidate their respective shares. These shares are passed down through a trust, which gives the beneficiaries of the trust a stepped-up basis that allows them to avoid paying capital gains taxes and depreciation recapture.

Of course, there are some downsides that come with utilizing 721 UPREIT exchanges, including:

·      Inability to Make Future “Like-Kind” Exchanges: When an investor relinquishes their property into an UPREIT, they receive OP Units in exchange. These REIT shares cannot be exchanged for other “like-kind” real estate in the future. If REIT shares are sold, they become subject to capital gains tax and depreciation recapture.

·      Lack of Control: Those who sell property using a 721 Exchange become passive investors; they no longer have a say in how properties owned by the REIT are managed. In fact, individuals no longer own real estate directly at all. All properties are exclusively owned by the REIT, with investors having an ownership stake in the operating entity overseeing those properties.

·      Greater Susceptibility to Market Swings: Unlike real estate assets held directly, which are illiquid in nature and have a low correlation with the stock market’s daily ebbs and flows, REIT shares can be more volatile if the REIT is traded publicly on an exchange. When the stock market contracts, REIT investors will often sell their shares much faster than someone would be able to sell individually-owned property. This can cause REIT values to plummet, even if only momentarily. Publicly-traded REIT shares tend to be highly correlated with the S&P 500 and therefore, are more susceptible to market swings.

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Is an UPREIT right for you?

Section 721 UPREIT transactions are limited to “accredited investors” as defined by the U.S. Securities and Exchange Commission. In order to qualify as an accredited investor, an individual must meet certain income or net worth requirements.

Assuming an investor is accredited, the best candidates for UPREITs are generally those who:

·      Own real estate with a low cost basis who would otherwise be subject to significant capital gains taxes upon sale;

·      Want to sell family-owned properties with multiple heirs involved;

·      Are seeking greater portfolio diversification, especially if a substantial portion of their wealth is currently tied up in a single asset; and

·      Want to transition from active to passive real estate investing, as UPREITs allow investors to hand off property management while continuing to seek passive income.

1031 exchanges typically garner the most attention in relation to how real estate owners can defer paying capital gains taxes. However, UPREITs are another potentially great solution for owners looking to dispose of property while simultaneously striving to preserve their capital.

If you’re interested in selling your property, contact us today to determine if a 1031 exchange into a DST and/or a 721 Exchange may be right for you.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. Information herein is provided for information purposes only and should not be relied upon to make an investment decision. All investing involves risk of loss of some, or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

1031 Risk Disclosure:

•         There is no guarantee that any strategy will be successful or achieve investment objectives;

•         Potential for property value loss – All real estate investments have the potential to lose value during the life of the investments;

•         Change of tax status – The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities;

•         Potential for foreclosure – All financed real estate investments have potential for foreclosure;

•         Illiquidity – Because 1031 exchanges are commonly offered through private placement offerings and are illiquid securities. There is no secondary market for these investments.

•         Reduction or Elimination of Monthly Cash Flow Distributions – Like any investment in real estate, if a property unexpectedly loses tenants or sustains substantial damage, there is potential for suspension of cash flow distributions;

•         Impact of fees/expenses – Costs associated with the transaction may impact investors’ returns and may outweigh the tax benefits

Potential Benefits of Passive Real Estate Management in DSTs

One of the reasons that investors often like to invest in real estate is because they like the idea of passive cash flow and passive real estate management. But what many investors quickly come to realize is that almost all real estate investing is not truly passive.

For example, investors in multifamily sometimes hire a property management company, only to quickly discover that even though they might not be managing the actual tenants, they usually end up having to manage the property managers!

And for those that invest in NNN properties believing that they won’t have any management responsibilities, they can rapidly realize that if the tenant files for bankruptcy or moves out, they’ll need to find a new tenant, negotiate a new lease, manage leasing agents, etc. or in the case of many NNN properties manage the tenants rent relief requests during a pandemic such as COVID 19…

And this isn’t to say that those investors cannot handle dealing with these issues, but why should they when there is an alternative that might be better in the form of a Delaware Statutory Trust (DST)?

There are generally 3 categories of how real estate investors manage their real estate:

1)    Investors that actively and personally manage their properties themselves

2)    Investors that hire a property-management company

3)    Investors that invest in DSTs

Investors that actively manage their properties:

For those that self-manage their investment properties, they might find yourselves fielding demanding calls and emails from tenants asking them to do things like unclog their toilets, change their burnt-out lightbulbs, fix the dishwasher, repair water leaks, get rid of alleged mold, etc…, and often these requests come in during the exact time that you’d rather not be dealing with those problems, like on the weekend, the middle of the night, on a holiday or when you’re on a vacation.

And that does not include finding tenants for your properties, interviewing them, running background checks, dealing with security deposits, doing walk-throughs, collecting rents on time, keeping up with city, county, and state rent laws and regulations, and more.

Then of course, sometimes dealing with tenants that have not paid their rent, or caused damage to your property, and then having to spend time, money and effort to evict them (if the city or state has not enacted an eviction moratorium as many have done during the COVID 19 pandemic). And then repeating the process again.

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Investors that hire a property management company

Oftentimes, finding a property management company that can properly manage investors’ property is no easy task. Some examples include property management companies charging their clients for items that should be the responsibility of the tenant. They could also fail to effectively communicate with the  tenants, failing to pay enough attention to the client’s property because they are also managing many other properties and don’t have the requisite manpower to manage it all.

In addition, not negotiating prices and terms well enough on behalf of their owner clients when it comes to 3rd party providers such as plumbers and electricians, hiring employees that don’t adequately understand property management issues, and charging too much for their services making it financially unattractive for owners to employ them.

Investors that invest in Delaware Statutory Trusts (DSTs)

Delaware Statutory Trust investments are commonly managed by professional, institutional level, real estate companies and are often referred to as DST sponsor companies. These DST sponsor companies will often employ large, experienced, and credentialed on site property management companies. These companies oftentimes have decades of property management experience, operate in various states, and have the infrastructure necessary to potentially help manage properties efficiently and effectively.

Moreover, these property management companies have another layer of oversight by large and professional asset management companies, adding another level of accountability to DST investors and relieving investors of having to manage the property managers themselves.

Notably, because these property management companies usually manage thousands, if not tens of thousands, of units and properties, they are able to offer lower management costs while providing for a potentially higher level of professional service.

Any accredited investor (generally defined as having a net worth of over 1 million dollars excluding primary residence, or meeting certain income thresholds) that is considering investing in real estate in a passive, hands-free, way, without subjecting themselves to the numerous issues often associated with managing the property themselves, should consider investing in a DST. 

The nice thing about a DST is that, under the current IRS code, when the property is sold the investor is able to do another 1031 exchange if they so choose. This is one reason that investors are choosing DSTs over Real Estate Investment Trusts (REITs) as you are not able to utilize the 1031 exchange tax deferral solution when you sell REIT shares.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. Information herein is provided for information purposes only, and should not be relied upon to make an investment decision. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

1031 Risk Disclosure:

•         There is no guarantee that any strategy will be successful or achieve investment objectives;

•         Potential for property value loss – All real estate investments have the potential to lose value during the life of the investments;

•         Change of tax status – The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities;

•         Potential for foreclosure – All financed real estate investments have potential for foreclosure;

•         Illiquidity – Because 1031 exchanges are commonly offered through private placement offerings and are illiquid securities. There is no secondary market for these investments.

•         Reduction or Elimination of Monthly Cash Flow Distributions – Like any investment in real estate, if a property unexpectedly loses tenants or sustains substantial damage, there is potential for suspension of cash flow distributions;

•         Impact of fees/expenses – Costs associated with the transaction may impact investors’ returns and may outweigh the tax benefits

Deferring Taxes in QOFs, 1031 Exchanges & DSTs

Investors looking to defer, reduce or exclude capital gains have various options for investing in real estate. Understanding the differences between each investment vehicle is imperative to developing an investment strategy that will help you strive to meet your financial objectives. To help provide direction, we have outlined the tax differences in investing in a Qualified Opportunity Fund (QOF), a Delaware Statutory Trust (DST) and a 1031 exchange—three of the most common investments relied upon today.

QOFs Versus 1031 Exchanges

QOFs and 1031 exchanges are some of the best-known investment options for deferring taxes. At first glance, it seems as though the tax benefits associated with investing in a QOF are similar to those realized when reinvesting through a 1031 exchange. Notable differences, however, do exist.

• Only proceeds from the sale of real estate can be rolled into a 1031 exchange, while capital gains from other assets, including stocks, bonds and business equipment, can be reinvested into a QOF.

• QOF investors are not required to identify a replacement property within 45 days or use a qualified intermediary. Instead, they are given 180 days to reinvest the proceeds from the sale of their prior assets.

• To be eligible for a full 1031 exchange tax deferral, investors must invest the value (equity and debt) of their investment realized upon sale. When investing in a QOF, only gains must be invested.

QOFs Versus DSTs

Another popular way to potentially defer paying capital gains tax on the sale of real estate is by reinvesting the proceeds from the sale of the asset into a DST. DSTs are eligible for the same tax benefits as 1031 exchanges, which means investors can use DSTs as a vehicle for deferring capital gains tax, sometimes indefinitely.

Compared to QOFs, DSTs have similar tax benefits; however, investors should be aware of some differences between the two investment vehicles.

• Investments in QOFs are intended for ground-up and value-add real estate. DSTs are typically stabilized, cashflow-generating properties.

QOF capital gains deferred through 2026 are eligible for a partial step-up; they must be held for at least 10 years to be excluded. DST investments are not eligible for exclusion but may be deferred indefinitely. The asset basis is stepped up to fair market value at the time of the investor’s death.

• Only proceeds from real property may be reinvested in a DST, whereas the short- and long-term gains on the sale of nearly all assets can be reinvested in a QOF.

• QOF investments have strict geographic boundaries; DST investments have none.

• DSTs must identify a property or portfolio of properties before accepting investments, while QOFs have a “blind pool,” meaning that capital deployment is flexible if 90% of assets remain in a Qualified Opportunity Zone (QOZ).

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Which Investment Vehicle May Be Right For You?

QOFs, 1031 exchanges and DSTs all have their pros and cons. So, when determining which investment vehicle may be best for you, consider the following.

• How much authority do you want to have over how funds are invested? With a QOF, investors are often unaware of how their capital will be invested; however, in a 1031 exchange or DST, assets have already been identified.

• Is a step-up in basis important to your legacy planning? When an investor passes away, any investment made in a QOF will not receive a step-up in basis to market value; therefore, heirs will pay the tax consequence upon selling ownership in the QOF.

• Has the asset you are planning to sell already been depreciated? Unlike 1031 exchanges and DSTs, QOFs do not allow you to defer depreciation recapture on the underlying asset upon sale.

Understanding Risk

No matter your investment strategy, whether it is in a DST, QOF or 1031 exchange, or whether your investment is leveraged or not, risk is always involved. There is no guarantee that your goals will be met, and investors are always at risk of losing some, if not all, of their cash flow or investment.

The income stream, the depreciation schedule, the investment itself or a change in the tax code may affect an investor’s tax benefits (e.g., a change in an investor’s tax bracket resulting in immediate tax liabilities).

Furthermore, for those considering investing in a QOZ, additional risk must be considered. As newer investments, most have little or no operating statements; returns and gains aren’t generally seen until the property is sold or refinanced; liquidity is limited; valuation of assets can be difficult; and as unregistered securities, the regulatory protections of the Investment Company Act of 1940 are not available.

Additionally, QOZs require speculative development of ground-up or heavy value-add projects in economically distressed areas. Opportunistic real estate deals such as these can be riskier than investing in a potentially stable, cash-flowing asset through a DST. Moreover, investors are always required to invest pledged capital, no matter the performance of the asset.

The differences between these investment options can create uncertainty, even with a seasoned investor. Therefore, it is highly recommended that investors considering investments in real estate or alternative real estate funds speak with a qualified professional.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. Information herein is provided for information purposes only and should not be relied upon to make an investment decision. All investing involves the risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

Investment in Industrial Real Estate: 5 Reasons to Consider it

Industrial real estate has become one of the most profitable and popular investment types in the United States. Industrial real estate opportunities provide a wide range of excellent options that might be ideal for institutional portfolios, private investors, or family offices with varying risk appetites and tolerances. Industrial real estate provides an extensive variety of property types, such as warehouse, distribution, manufacturing, and flex space. 

Although industrial assets might not have the aesthetics and curb appeal of other types of real estate, there has been a surge in demand for industrial investments over the last few years as the sector gradually transforms in order to accommodate many high-growth industries.

What is Industrial Real Estate?

Industrial properties include the following: 

It is worth noting that the types of industrial properties in different regions or areas often vary based on the local infrastructure. For example, some areas are pretty heavy on manufacturing, and some towns and cities may have limited options for industrial investments. 

There is no doubt that automation and technology have played a massive role in industrial property development over the last few years. Also, it has become a primary expense for industrial landlords whose tenants have resorted to automation and robotics for their business activities. This innovation has made industrial real estate a very lucrative and exciting investment category.

Many experts consider industrial real estate one of the strongest and most attractive asset classes as it’s usually relatively inexpensive to own and operate. It also typically provides a more stable cash flow than other real estate sectors, like retail and office.

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Here are five reasons to consider investing in industrial real estate:

1.    High Demand

Industrial properties usually stay vacant for considerably less time than other kinds of commercial real estate, such as office space. CBRE reveals that leasing demand for industrial property, such as distribution centers, has been mainly driven by transportation and warehousing, retail, and wholesale (including e-commerce), as well as processing and manufacturing. Also, as industrial real estate plays a huge part in infrastructure, it is usually in high demand in specific areas. 

And demand for industrial properties stays high as almost every product we encounter or use has likely passed through an industrial property in one way or another. Hence, these properties are considered to be part of the logistical supply chain and thus indispensable. Due to the current popularity of e-commerce and the resultant need for larger-scale distribution and fulfillment centers, this industry has the potential to flourish in the future, resulting in the possibility of continued high-demand.

2.    Less Maintenance

Owning a commercial property comes with its fair share of expenses and overhead, such as repairs, upgrades, and renovations. These expenses will likely be necessary throughout the entire duration of your ownership and tend to become both time-consuming and costly.

However, overall, the maintenance or upgrades required are usually much less than in most other sectors. For example, many industrial properties are usually big, open areas with high, exposed ceilings and poured concrete floors, and so there is no need for items like flooring, high-end fixtures, and sound-proofing.

3.    Reasonable Vacancy Costs and Lower Vacancy Rates

One of the least attractive aspects of real estate investment is facilitating your property for the next tenant once the previous tenant moves out. This means that in the case of residential or retail tenants, landlords will likely have to pay the remaining heating bills, insurance taxes, and property taxes. And if the residential tenants have left the property in bad shape, revamping the property in order to attract new tenants can be expensive. However, with industrial real estate properties, such as distribution centers, these costs can be much lower. 

Although office vacancies have surged as employers and companies prepare for a post-COVID-19 future of distributed work, the industrial real estate market is hotter than ever. This is due to a pandemic-fueled surge in e-commerce as well as increased consumer demand to receive more products at Amazon-like speeds. See Marcus and Millichap.

4.    Can Be Easier to Liquidate

Due to currently high overall demand for industrial properties, these properties generally remain on the market for shorter periods of time than other real estate asset classes.

5.    Higher Potential Yields

With typically fewer market fluctuations, longer leases, and less turnover, investors are likely to potentially benefit from a greater ROI. Although all investments have associated risks, industrial real estate is often considered more recession-resilient than other types of properties, and these properties tend to hold their value and sometimes possibly appreciate over time. As industrial properties can have higher rental rates, this can also lead to higher yields for investors.

Contact Perch Wealth today to discuss opportunities about investing in industrial properties.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. Information herein is provided for information purposes only and should not be relied upon to make an investment decision. All investing involves risk of loss of some, or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

1031 Risk Disclosure:

•         There is no guarantee that any strategy will be successful or achieve investment objectives;

•         Potential for property value loss – All real estate investments have the potential to lose value during the life of the investments;

•         Change of tax status – The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities;

•         Potential for foreclosure – All financed real estate investments have potential for foreclosure;

•         Illiquidity – Because 1031 exchanges are commonly offered through private placement offerings and are illiquid securities. There is no secondary market for these investments.

•         Reduction or Elimination of Monthly Cash Flow Distributions – Like any investment in real estate, if a property unexpectedly loses tenants or sustains substantial damage, there is potential for suspension of cash flow distributions;

•         Impact of fees/expenses – Costs associated with the transaction may impact investors’ returns and may outweigh the tax benefits.