1031 Exchange Pros & Cons

The main reason for doing a 1031 exchange is the deferral of your capital gains tax. In a 1031 exchange you can exchange for like kind property. This means if you sell a single family residence, you can sell for a similar single family residence. You must exchange equal or great equity in the relinquished property for your new property. If you have any debt, that needs to be replaced as well. For some investment property owners with a low or no cost basis, this could defer out a large amount of capital gains tax. For real estate owners in a highly taxed state like California, that could be a 40%+ tax savings. The advantage to a 1031 exchange could allow you to exchange up to a newer, or nicer property. If you are selling an investment property that is debt free, you can exchange for a like kind property without having to get a mortgage. These are just some of the advantages when doing a tax deferred 1031 exchange. 

Advantages To A 1031 Exchange 

• Tax Deferral 
• Exchanging for a newer property
• Exchanging debt free
• Diversify into multiple smaller properties

There are some great benefits to a 1031 exchange when selling real estate. There are some pitfalls when it comes to selling an investment property. The rules for a 1031 exchange are stipulated by the IRS. These rules give you 45 days from the date you close escrow to identify your replacement property. You then have 180 days to close on your replacement property. You must setup a qualified intermediary prior to closing escrow on your relinquished property. If you do not setup a qualified intermediary account prior to your close of escrow, you are ineligible to initiate a 1031 exchange. The 1031 exchange rule allows you to identify 3 replacement properties, identify 200% of your relinquished property, or the 95% rule. This short timeline can make it difficult to find replacement properties in that short amount of time. If you do not identify a replacement property in the allotted amount of time given by the IRS, you are subject to the capital gains tax. If you do not close escrow within the 180 day timeline, you are subject to the capital gains tax. 

In a real estate environment where there is limited inventory, this could pose a challenge to the real estate investor. Since you have to replace any debt that you had on the relinquished property, you could have a higher mortgage payment than you previously had. This could impact you yield on your investment bringing down your profit. A lot of properties tend to fall out of escrow. If you have only identified 1 replacement property and that property falls out of escrow, you are then subject to the capital gains tax. These 1031 exchange cons can pose a large tax liability exposure for the real estate investor. 

Cons Of The 1031 Exchange

• Limited time to identify a replacement property
• Low inventory of replacement properties
• Exchanging debt for a higher interest rate 
• Falling out of escrow leading to capital gains tax exposure
• Settling on a sub par replacement property
  

Due to these 1031 Exchange Pros & Cons, real estate investors are looking for 1031 exchange alternatives to the physical like kind replacement properties. What are some viable 1031 exchange alternatives that real estate investors can chose? 

• Delaware Statutory Trust
• 721 UPREI 

There are some options that allow the real estate investor to do a tax deferred exchange without having to manage a physical property. The Delaware Statutory Trust is an investment vehicle that allows the real estate owner to do a 1031 exchange into an institution grade investment property and be a fractional owner with other investors. This accomplishes the tax deferral of capital gains tax, provides passive monthly income, deprecation benefits, and potential appreciation benefits. If you would like to learn more about the Delaware Statutory Trust, you can click the hyperlink to read a full DST guide. 

The 721 UPREIT is a tax deferral option that allows the real estate investor to do an exchange into a REIT fund that allows the investor to receive passive monthly income as well as the opportunity for growth with the tradeable shares. This gives the real estate investor a liquidity option at their disposal. This investment can remain in perpetuity for the rest of the investors life without having to pay capital gains tax if they decide not to liquidate any shares. If you would like to learn more about the 721 UPREIT, you can click the hyperlink to learn more about the opportunity. 

If you would like to speak to someone about these options if you are selling an investment property, you can fill out the form below or all our office directly to learn more at - 805-583-2720. 

*Disclosure:
This website is neither an offer to sell nor a solicitation of an offer to buy any security which can be made only by a prospectus, or offering memorandum, which has been filed or registered with appropriate state and federal regulatory agencies, and sold only by broker dealers and registered investment advisors authorized to do so.
Additionally, we cannot offer any of our open offerings unless we have a pre-existing relationship with a customer. Once we have obtained sufficient information to perform an evaluation of our new customers’ financial circumstances and sophistication in determining his or her status as an accredited investor, we would be able to discuss future offerings once they become available.

**The properties depicted here are representative examples of the types of property that can be owned within a DST. They are not intended to depict or represent any particular investment offering.

** *It is important to note that distributions from real estate and DST 1031 exchange properties, as well as past performance, is not guaranteed, as it is a function of the underlying real estate and tenants and their economic performance. Just as with all other types of real estate, estimated distributions could be lower than anticipated in a 1031 exchange DST investment. It is very important for you as a 1031 exchange DST investor to believe in the real estate, its location and its tenants before investing, as well as to review the risk factors of the offering materials in their entirety.

* Important Risk Factors to Consider Investments in real estate assets are subject to varying degrees of risk and are relatively illiquid. Several factors may adversely affect the financial condition, operating results and value of real estate assets. These factors include, but are not limited to: • changes in national, regional and local economic conditions, such as inflation and interest rate fluctuations; • local property supply and demand conditions; • ability to collect rent from tenants; • vacancies or ability to lease on favorable terms; • increases in operating costs, including insurance premiums, utilities and real estate taxes; • federal, state or local laws and regulations; • changing market demographics; • changes in availability and costs of financing; • acts of nature, such as hurricanes, earthquakes, tornadoes or floods • economic risks associated with a fluctuating U.S. and world economy, including those resulting from the novel coronavirus and resulting pandemic.