Exchanging Equities / Property Trade Counseling
Exchanging Equities / Property Trade Counseling – Services Provided by Real Estate Asset Advisor David Dornbos
Exchanging Equities / Property Trade Counseling should be part of any commercial investment sale and should be considered long before any contract is accepted by an owner. The impact of taxation on the sale of an investment property can dramatically reduce your hard-earned cash returns at the conclusions of any business or real property transaction.
There are several sanctioned tax deferral methods that are outlined in Section 1031 of the Internal Revenue Code. A Delaware Statutory Trust (DST) and certain Real Estate Investment Trusts (REIT) can be employed to allow an owner to transfer their ownership interests in one property to a new ownership in another ‘like-kind’ property and deferral taxes on the initial transaction.
There are strict regulations and time frames that must be met to be considered as a qualified property exchange under these provisions of Section 1031 of the Federal Tax Code.
There are effectively three types of tax deferred exchanges that are recognized under Section 1031 of the Federal Tax Code:
Simultaneous Exchange:
Occurs when the sale of an owner/investor qualified property closes, and the purchase of a replacement property occurs on the same day.
Delayed Exchange:
Occurs when the sale of the owner/investor original property is closed first, and the replacement property is purchase within 180 days following the initial closing. An owner/investor has 45 days following the original sale of their qualified investment property to identify up to three (3) potential replacement investment properties.
Reverse Exchange:
A reverse exchange can occur when an owner/investor chooses to acquire the replacement property first before selling closing on the sale of their original property.
In all three of these examples of a qualified 1031 exchange, an owner/investor must use a qualified intermediary to receive title, accept funds and transfer ownership.
There are very specific rules and deadlines that must be met. The exchanged properties must meet ‘like-kind’ standards, the proceeds of the sale must be fully reinvested, or any cash received may be subject to taxes, the basis associated with the initial sale must be moved to the replacement property, it can be increased but not reduced or eliminated, the trade property cannot be used for personal use, will be taxed, the parties to the transaction must agree to use a qualified intermediary to close both transaction, and the owner/investor must take title to the new property under the same name as the property they are selling.
There are risks and challenges to property exchanges that must be considered. When combined with a 45-day identification period, finding suitable replacement properties is a major challenge in today’s market. Complying with strict IRS rules and regulations can add to the difficulty of successfully completing an exchange.
Market fluctuations can impact the value of the properties involved. When exchanging into a DST, or REIT the projected investment return is highly dependent on the competency of the management group who will be overseeing the daily operations of the properties under their control.
Property exchanges are popular for those looking to optimize their real estate portfolios without incurring immediate tax liabilities. A Seller and Buyer willingness to consider trading real estate in exchange for cash at closing can also open a world of new possibilities to help create and expand the market appeal and exposure while simultaneously serving as a creative way to meet your investment goals and needs.
Investors engage in these transactions to enhance returns, manage risk, and better align their portfolios and changing market conditions.
A 1031 exchange, named after Section 1031 of the Internal Revenue Code, allows investors to defer capital gains taxes on the sale of a property by reinvesting the proceeds into a like-kind property. While this provision primarily applies to direct property exchanges, it also extends to equity trades into alternative investment vehicles meeting certain criteria, including REITs and DSTs.
One of the primary advantages of opting for an equity trade through a 1031 exchange is the enhanced liquidity and diversification it offers to commercial real estate investors. By transitioning equity into REITs or DSTs, investors gain exposure to a diversified portfolio of properties across various sectors and geographic regions, mitigating risk and enhancing portfolio resilience. Moreover, these alternative investment vehicles provide readily tradable securities, allowing investors to access liquidity without the constraints associated with direct property ownership.
The cornerstone benefit of a 1031 exchange is the deferral of capital gains taxes, enabling investors to preserve wealth and optimize returns.
By reinvesting proceeds into REITs, DSTs, or other qualified exchange forms, investors defer tax liabilities, thereby maximizing capital available for investment and compounding returns over time. This tax-efficient strategy not only facilitates wealth preservation but also fosters long-term wealth accumulation through the power of compounding.
Direct property ownership entails inherent management responsibilities and operational risks, ranging from tenant management to property maintenance. By transitioning equity into REITs or DSTs, investors delegate these management burdens to professional asset managers, thereby freeing up time and resources while mitigating operational risks.
Additionally, investing in a diversified portfolio of properties through alternative investment vehicles inherently reduces exposure to idiosyncratic risks associated with individual properties, further safeguarding investors’ capital.
Equity trade through a 1031 exchange empowers investors to capitalize on prevailing market dynamics and seize investment opportunities with agility and flexibility. In a rapidly evolving real estate landscape, where market cycles and sectoral trends fluctuate, the ability to swiftly reallocate capital into promising opportunities is invaluable.
REITs and DSTs offer investors the flexibility to adapt their investment strategies in response to changing market conditions, optimizing portfolio performance and maximizing risk-adjusted returns.
The strategic value of opting for an equity trade through a 1031 exchange into REITs, DSTs, or other tax-deferred exchange forms cannot be overstated. By unlocking liquidity, diversification, and tax deferral benefits, this approach empowers commercial real estate investors to optimize returns, preserve wealth, and mitigate risks effectively.
By delegating management responsibilities and capitalizing on market dynamics, investors can enhance portfolio resilience and capitalize on emerging opportunities, positioning themselves for long-term success in the dynamic landscape of commercial real estate investment.
Have Questions? Give David Dornbos a call today!
