Yes, you can invest in a REIT by completing a 1031 Exchange
Investors looking for a tax deferred exchange investment are often attracted to Real Estate Investment Trusts or REITs as they are commonly known. They generate a lot of interest but also a lot of questions.
One of the most frequently asked questions is “Can I do a 1031 exchange of the relinquished property proceeds into a REIT as replacement property?”
A REIT is a company (sometimes publicly traded) that owns, and usually manages, income producing real estate. REIT portfolios are typically diversified by industry, geography and tenant and can include shopping malls, apartments, office buildings, hotels, medical facilities and warehouses. Popular features of a REIT that attract investors include; professional management, diversification and the potential for equity appreciation.
But before you get carried away… there are strict rules and regulations that govern a REIT. An investor cannot do a 1031 exchange into shares of a REIT because the shares of a REIT are considered personal property even though the REIT, at the entity level, owns real property assets. Investors pursuing a 1031 exchange tax must exchange property that is considered ‘like-kind’ – defining ‘like-kind’ can be confusing and understanding what property is eligible for a 1031 exchange is vital to the success of the exchange; the investor must exchange real property held for investment or business purposes for other real property held in the same way. REIT shares are not considered ‘like-kind’.
But, although investors cannot utilize a 1031 exchange into a REIT, there is a two-step strategy that can allow investors to own the equivalent of shares in a REIT. Section 721 of the Internal Revenue Code provides an alternative strategy to a Section 1031 exchange allowing the property owner to convert their property into shares of a REIT – here’s how:
Step #1 – 1031 Exchange into a DST:
By exchanging into a Delaware Statutory Trust (DST) Investors may participate in an UPREIT (Umbrella Partnership Real Estate Trust) pursuant to IRC §721. UPREITs provide an exit strategy for owners of property who rather than exchanging for another real property in a 1031 exchange, prefer the benefits of owning an interest in an UPREIT’s operating partnership. These operating units (OP units) benefit from the REITs diversification, capital potential and distributions of operating income. Within an 18-24 month time span the taxpayer has the option to UPREIT or stay in the DST investment as a factional owner. A properly structured DST offers fractional ownership of real property and qualifies for tax deferral. One of the many benefits of a DST is the ability for investors to exchange out of actively managed real property, into a passive investment in a fractional ownership of institutional grade replacement property with high quality commercial tenants. Note: Not all REIT’s are structured for this type of investment exchange so it’s wise to review the guidelines and timelines carefully.
Step #2 – UPREIT from the DST into OP Units of a REIT:
By utilizing IRC §721 the investor performs an UPREIT from their DST shares into operating partnership units (OP Units) in a REIT. The OP Units usually have all of the benefits as direct ownership in a REIT and are convertible into REIT shares. The UPREIT is a tax deferred transaction under IRC §721. As long as the OP Units are held, the investor can maintain the tax deferral. If the REIT shares are publicly traded, they can be sold on the open market for cash. It should be noted however, that conversion of OP Units to REIT shares by the owner does create a taxable event, but investors can decide to stagger those conversions for liquidity and tax management reasons. Upon an OP Unit holder’s death, the beneficiaries of the OP Units will receive a stepped-up basis in the OP Units, like real estate, conveniently providing greater tax planning flexibility.
In conclusion, the benefit of owning shares in a REIT can be a diversified real estate holding portfolio, professional management, liquidity events and potentially greater cash flow. A diversified portfolio may be achieved by investing in various states (geographic), tenant mix, REIT’s and asset classes. Many investors find a REIT to be a valuable estate planning vehicle – as it is possible to sell a portion of the shares in the REIT to offset capital gains taxes, and by staggering investment time frames, to defer the tax hit so that it doesn’t occur all at once.
There are many options for investors to consider and a REIT is just one part of the investment puzzle. If you’d like to see the big picture – what the puzzle looks like with all the pieces in place, the experienced advisory team at Diversified Investment Strategies (DIS) will meet with you for a no-obligation consultation to analyze your investment needs, and devise the best strategy to meet those goals.
For further information regarding DST’s, 721 UP-REIT’s and alternative 1031 exchange options please contact Bryan Hakola of Diversified Investment Strategies 866-261-0104 or email Bhakola@diversified1031.com or visit our website www.diversified1031.com
Securities products involving REIT’s and/or DST’s are for accredited investors only (a net worth of greater than 1 million dollars – exclusive of primary residence). Securities products are offered through Concorde Investment Services, LLC, member FINRA/SIPC. Office of supervisory jurisdiction: 1120 East Long Lake Drive Suite 200, Troy, MI 48085. Diversified Investment Strategies and Diversified Real Estate Advisors are independent of Concorde Investment Services, LLC. All information provided is for educational purposes only. The material contained herein does not constitute an offer to sell and is not an offer to buy real estate or securities. Such offers are made only by a sponsor’s memorandum, which is always controlling and available to accredited investors only. There are material risks associated with the ownership of real estate, including but not limited to, tenant vacancies, loss of entire principal amount invested, and that potential cash flows, returns, and appreciation are not guaranteed. Past pricing structures may not be indicative of future pricing and may not result in positive returns. Diversified Investment Strategies and Diversified Real Estate Advisors are unaffiliated entities with Concorde Investment Services, LLC.
Bryan Hakola
Diversified Investment Strategies
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