HAVE YOU EVER THOUGHT?
“I wonder if I could 1031 Exchange into a real estate investment trust (REIT)?”
Technically an investor is not able to exchange directly into a REIT as those are not considered like-kind” (real property to shares).
It can be accomplished by exchanging into a DST property for two years (IRS requires two years or two tax periods) that will eventually be UPREIT’d into the REIT via a 721 Exchange. Held for two years, the property is then pushed into the REIT (via 721 Exchange) on a tax-deferred basis. Now you own shares of the REIT, which can be sold after one year of ownership of the shares.
This structure offers investors the ability to own interest in a diversified real estate portfolio of institutional quality properties that are professionally managed and offer potential diversification, income, tax benefits, liquidity (unlike a DST). REITs generally have properties located in many geographic locations, as well as having tenant, industry and sometimes asset class diversification. As a shareholder of the REIT, you would no longer have interests in a single asset. The REIT provides the similar benefits of potential appreciation of the real estate, depreciation tax shelter and income.
HOW IT WORKS
Umbrella Partnership Real Estate Investment Trust (UPREIT)
Step 1: Completes 1031 Exchange As A Beneficial Interest Holder
Investor completes 1031 exchange as a beneficial interest holder of a Trust and purchases a beneficial interest of a DST “Delaware Statutory Trust”. Receives quarterly distributions from from the DST property.
Step 2: Hold Ownership for 2-3 Years
Holds ownership of the DST for approximately 2-3 years then Operating Partnership exercises its purchase option. Contribute their beneficial inters of the DST or the REIT
Step 3: Receive OP Units
Investor receives OP Units on the operating partnership (REIT). Now owns and interest in a Diversified Polio of professionally managed institutional quality assets while receiving a monthly income distribution.
Step 4: Hold OP Units For 1 Year
Hold OP units for at least one year and has the option to redeem for common stock or cash.
Step 5: Hold OP Units or Shares or Sell
Hold OP units or shares in perpetuity and receive income or sell op units/shares and pay tax on the amount sold in that tax year. Op Units are fully divisible and estate receives a setup up basis upon death.
It is important to note REIT shares are not eligible to be used in a 1031 Exchange. Once the UPREIT occurs and you own shares or operating units, you can no longer 1031 Exchange again. If the investor decides to sell all or a portion of his/her shares, he/should would pay capital gains tax on the amount of shares he/she sold in the particular tax year. If the shares of the REIT are sold, or the REIT sells a portion of the portfolio and returns capital to the investors, the investors will be required to recognize any capital gain or loss when they file their taxes.
This is a popular estate planning tool because taxes can be spread out over time, not hit at once. The capital gains taxes are paid only on the amount of shares sold at any given time. If you are preparing to pass your assets down to your family, if suitable, a 721 Exchange is a beneficial strategy because physical real estate can be difficult to sell and lead to conflicts during asset division.
If your estate should exchange via a 721, you will receive all the potential benefits during your lifetime, and upon your death, the shares can be split equally and either held or liquidated by your heirs. Since the shares are passed through a trust, your heirs will receive a step-up in basis avoiding capital gains and depreciation recapture taxes that were initially deferred by the estate.
Still Have Questions? Need Help Determining If 1031 Exchanges Are Right For You?