Asset Preservation and Impartation for Retirement through Real Estate

Authored by Nathan Webb

*Disclaimer, this article is for informational purposes only and should not be considered tax, legal, or financial advice. Please consult with an appropriate advisor on the validity and accuracy of this information for specific scenarios.

Most real estate investors are aware of a 1031 exchange and how it defers taxes on the sale of real estate so long as the proceeds are used to purchase more real estate. 1031 exchanges deal exclusively in real property to real property transactions, with many different asset classes qualifying as real property. An investor can sell multiple single-family residences and buy 1 or 2 larger retail net lease properties, as an example, with the entire transaction being performed through a 1031 exchange tax deferred and moving into less management intensive passive income producing assets as a result.

Fractional interests of larger real estate assets also qualify for a 1031 exchange such as producing Oil & Gas Mineral Rights, percentages of interest in large multifamily operations through Tenants in Common, and even fractional interests of single or multiple investment grade assets through a Delaware Statutory Trust, such as Amazon fulfillment centers, or name brand grocery stores couple with other retail assets like dollar stores, auto part stores, urgent care facilities, and FedEx distribution centers. TICs and DSTs can even account for debt/equity requirements in a 1031 exchange through pre-placed non-recourse debt back by the properties themselves. Investment sizes can be made for as little as $100,000 in many cases and can even be tax advantaged through depletion benefits or cost segregation. All of these fractional interest options also come with an experienced in place management team so that the investment is very passive requiring the exchanger to simply collect checks on a monthly or quarterly basis.

A lesser known tax strategy for real estate investors is moving into a Real Estate Investment Trust through a 721 exchange. In a 721 exchange a property is purchased in trade for operating units of the REIT, not cash. Operating units, like shares or other fractional interests, give monthly or quarterly passive income to investors and can also see appreciation as the REIT grows in size and value and uses their access to other forms of leverage to favorably do so. There are also additional advantages to owning these operating units in that investors can sell them off at their tax basis first, essentially cashing out their original equity over time and tax free while leaving in their appreciation to continue growing and generating passive income. Those operating units can also be held in a revocable living trust, allowing them to be inherited at a step up in basis and investors can more easily divide those units among their heirs than an odd number of properties.

In a 721 exchange the seller takes no constructive receipt of cash on sale, no profit or loss is realized on that sale and taxes are deferred similar to a 1031 exchange. Since a REIT often has strict purchase criteria, not every property qualifies for a 721 exchange as a REIT may not want to buy them or go through a 721 exchange purchase agreement for small properties. However, an investor can 1031 exchange into a Delaware Statutory Trust sponsored and managed by a REIT with properties they want to hold long term, and that sponsor will then offer a 721 Exchange, often called an UPREIT, or another 1031 Exchange option in 3-5 years as the DST qualifies for another tax deferred exchange after a period of time.

For example:

Bob is a real estate investor who owns 18 single family rental properties. They are held in multiple LLCs but all by the same holding company LLC and that holding company is in a Living Revocable Trust. Bob has secured a buyer of his 18 properties for $5M, has a $1.75M loan payoff, and will effectively net $3.25M in proceeds. Since he has purchased the properties over the last 20 years, they have seen quite a bit of appreciation and are nearly fully depreciated. He elects to do a 1031 exchange as his Federal Capital Gains, State Capital Gains, Depreciation Recapture, and Net Investment Income Tax due would be over $1M. Bob partners with a sponsor via Tenants in Common for $1M and purchases 10% undivided interest of a large apartment building in a growing part of town. He signs, along with the sponsor, on Fannie Mae non-recourse debt which helps cover the majority of his replacement debt needs. He also elects to purchase a diversified portfolio of Investment Grade Net Lease properties in a Delaware Statutory Trust with a 721 Exchange / UPREIT option for another $1M that also includes 60/40 preloaded non-recourse debt, which covers his remaining debt requirements for the 1031 exchange. With the remaining $250,000 in equity, Bob purchases Oil & Gas producing royalties for that exact amount. Bob has successfully completed a 1031 exchange into passive investments diversified across multiple asset classes and all allowing his heirs to take a step up in basis. Bob spends his days traveling to see the grandkids while living off of the cash flow and no longer has to deal with tenants and toilet issues as a result.

Nathan Webb

American Accommodators

1031 Exchange Executive & Advisor

Direct: 470.387.1031

Mobile: 805.405.4740

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