Can You 1031 Exchange Into a REIT?
Investing in real estate can be an excellent strategy for diversifying your portfolio. Areal estate investment trust(REIT)can be an ideal investment option if you want cash flow via real estate withoutmanagement responsibilities.
So, can you1031 exchange into a REIT?No, investors cannot1031 exchangeinto a REIT. However, you have some alternatives to consider for capital gains deferment, including umbrella partnership real estate investment trusts (UPREITs) and Delaware Statutory Trusts (DSTs).
This guide includes the basics of REITsand what investment options are available to youto successfullydefer capital gains taxes through a multi-stepprocess.
What Is a REIT?
A real estate investment trustis a company thatoperates, owns, and financesincome-producing real estate. With a REIT, investorscombinetheir funds to purchase assets, which are held in a portfolio.REIT investors donotdirectly own thereal estatebut doown a share or shares in the REIT. A REIT company managesreal estate properties, collects the rent,and distributes the money to shareholders via income dividends.
A REIT 1031 exchange isnotpossiblesince the Internal Revenue Service (IRS) views a 1031 property as real property and a REIT aspersonal property. An investment property is a tangible asset that meets the IRS definition of real property. A lawful 1031 exchange per theInternal Revenue Code (IRC) Section 1031permits investors to exchange their investment property for a like-kind asset to defer capital gains taxes.Investors cannotcomplete a 1031 exchange into a REITsince they are not technically like-kind assets.There is a way to obtain similar tax deferment results, which we will review later in this article.
There are various kinds of REITs, and the different REITs invest in specific asset types. The primary types of REITs are private REITs and public REITs. Whether REITs are private or public, an investor does not have direct ownership of the assets.
Private REITs
Private REITs are exempt from registration with the Securities and Exchange Commission(SEC)and are not on any stock exchange. Unlike a publicly traded REIT, a share in a private-placement REIT is usually available only to accredited institutional investors. Because a private REIT is not publicly traded, it is not a highly liquid investment like a public REIT.
Public REITs
There are two types of public REITs:
- Public traded:Many REITs are publicly traded, making them easier to invest in than real estate assets. Publicly traded REITs offer the advantage of being liquid investments, as people can buy and sell them like stocks.
- Public non-traded:Publicnon-tradedREITs arenot available on any national stock exchange. These REITs must register with the SEC. However, unlike stocks, it’s not easy to buy and sell them via an exchange. A share in a public non-listed REIT has limited liquidity, as investors can only sell them through a repurchase program or a secondary market.
Alternatives for a1031Exchangeto a REIT
Since investment property owners cannot1031 into a REIT,buyingshares of publicly traded REITs with proceeds from selling your rental or business propertywill not qualify for a 1031 exchange. You will be subject to depreciation recapture tax and capital gains tax. Instead, consider these alternatives:
UPREITs
AnUPREIToffers a unique solution to real estate investors who want to exchange an investment property for REITOperating Partnership (OP) unitsand defer their capital gains tax. When you have an UPREIT, anOperatingPartnership owns the real estate. The REIT is the sole general partner and owns a significant share of theOPunits.
To defer your capital gains tax, you can use an UPREIT and contribute your property to the OP in exchange for OP units. You will not own shares of the REIT, but you will own units in theOperatingPartnership.
You can use an UPREIT to ultimately exchange your investment into a REIT. Many REITs allow UPREITs as a way forDSTinvestors to convert DST interests to OP units in an UPREIT. You can defer capital gains taxes because the conversion is made in a partnership.
One drawback with the UPREIT process is you cannot do a 1031 exchange to convert the UPREITback into real property. The investment must remain in UPREIT OP units to defer capital gains taxes.
About 1031 Exchanges and DSTs
Another option for deferring taxes in an exchange is with Delaware Statutory Trusts.You can purchase an interest in a DST property through a 1031 exchange. A DST is considered a like-kind asset underIRC Revenue Ruling 2004-86.
What Are DSTs?
DSTs are a type of partnership in which an investor owns an undivided interest in real property. The IRS allows an investor to use 1031 exchanges to defer the taxable gain if they then use the proceeds to invest in a DST property.
Doing a 1031 into a DST is the same process as a typical 1031 exchange. The time frames are the same,and the seller also works with a qualified intermediary. Regulations differ in a DST’s operation and structure.
There are severalpros and cons of DSTsinvestors must consider.If you areunsure whether DSTs are right for you, 1031 Crowdfunding can advise you further.
DSTs With a 721 Option
Exchange funds can be invested in a DST through a process that combines the DST and REIT structures. The DST process can be used to reinvest exchange funds into REIT shares through a 721 exchange, a tax-neutral process. Here is how the process works:
- You identifyaDSTwith a 721 option.
- You purchaseintotheDST.
- After a waiting period, theDSTcontributes the asset(s)you purchased intothe REITportfolio.
- The REIT then issues units in the REIT’s Operating Partnership in exchange for the contribution.
This process allows you to defer your taxes from the 1031 exchange into the DST and from the 721 exchange to REITs.
Contact 1031 Crowdfunding to Learn More
At 1031 Crowdfunding, we offer a turnkeysolution for your 1031 exchange. Our experienced team of securities and real estate professionals has created an online marketplace ofvetted real estate offerings. We provide inspired solutions to our clients to allow them to invest with confidence. Our DSTs give 1031 exchange investors a potential backup plan, so you can rest assured that we will invest exchange funds in replacement properties instead of taxing them for capital gains.
Along with DSTs, we also have opportunity zone funds, real estate investment trusts, bridge funds,and other real estate investment funds.Registerfor an investor accounttoday.
This material does not constitute an offer to sell or a solicitation of an offer to buy any security. An offer can only be made by a prospectus that contains more complete information on risks, management fees and other expenses. This literature must be accompanied by, and read in conjunction with, a prospectus or private placement memorandum to fully understand the implications and risks of the offering of securities to which it relates. As with all investing, investing in private placements is speculative in nature and involves a degree of risk, including loss of your principal. Past performance is not necessarily indicative of future results and forward-looking statements and projections are not guaranteed to achieve the results described and your actual returns may vary significantly. Investments in private placements are illiquid in nature and there may be no secondary market or ability to sell the investment should the need for liquidity arise. This material should not be construed as tax advice and you should consult with your tax advisor as individual tax situations will vary. Securities offered through Capulent, LLC Member FINRA, SIPC.
