Real estate investment trusts (REITs) offer a unique opportunity for investors to gain exposure to the real estate market, without the hassle of direct property ownership. One popular tax strategy for investing in REITs is through the use of 1031 exchanges. In this article, we’ll discuss the benefits of investing in REITs, the fundamentals of 1031 exchanges, and how to leverage this powerful tax-deferral tool with the help of 1031 Exchange Place.
Benefits of Investing in REITs
- Diversification: REITs provide an efficient means to diversify your investment portfolio, as they invest in various property types and geographic locations. This diversification can help mitigate risk and improve overall returns.
- Liquidity: Unlike direct property ownership, REITs are traded on major stock exchanges, making them a more liquid investment option.
- Passive income: REITs are required to distribute at least 90% of their taxable income to shareholders, which often results in attractive dividend yields for investors.
- Professional management: REITs are managed by experienced real estate professionals, which can potentially lead to better investment decisions and higher returns.
Understanding 1031 Exchanges
1031 exchanges are part of Section 1031 of the Internal Revenue Code. This allows investors to defer capital gains taxes on the sale of an investment property, provided that another “like-kind” property is acquired with the profit. The term “like-kind” is broad but does generally mean real estate for real estate. It typically does not allow for the direct exchange into a Real Estate Investment Trust (REIT) because a REIT is a security, not a direct real estate investment. But continue reading about a solution to defer those taxes.
What Is A 721 Exchange?
721 Exchange is part of Section 721 of the Internal Revenue Code, also known as a UPREIT transaction. This exchange permits investors to swap actual real property for an interest in a professionally managed portfolio of real estate held by a REIT, specifically an Umbrella Partnership REIT (UPREIT). This transaction allows the deferral of capital gains taxes on the transfer, and the investor receives Operating Partnership (OP) units equivalent to the value of the property contributed.
Investing in REITs through 1031 Exchanges
While 1031 exchanges are commonly used for direct property investments, they can also be used to invest in REITs, specifically through a structure called a Delaware Statutory Trust (DST). A DST is a separate legal entity that owns, operates, and manages real estate assets, and can qualify as a like-kind property under the 1031 exchange rules.
Here’s how the process works:
- Sell your property: Work with a qualified intermediary (QI) to sell your existing investment property. The QI will hold the proceeds from the sale in a secure escrow account.
- Identify replacement properties: Within 45 days of the property sale, you must identify potential replacement properties. This is where a company like 1031 Exchange Place can help you select suitable DSTs that hold interests in REITs.
- Complete the exchange: Within 180 days of the property sale, you must acquire the replacement property (DST interests) using the funds held by the QI. The QI will facilitate the transaction, ensuring compliance with 1031 exchange rules.
- Hold and manage your investment: Once you’ve invested in the DST, you’ll become a beneficial owner of the underlying REITs. You’ll receive income distributions and benefit from any potential appreciation of the real estate assets.
We Can Help
Investing in REITs through 721 exchanges or DSTs through 1031 exchanges offers a unique opportunity to diversify your real estate portfolio while enjoying the tax benefits of a like-kind exchange. With the assistance of 1031 Exchange Place, you can take advantage of this powerful investment strategy and potentially enhance your long-term returns.