Investors looking to scale their real estate portfolio and increase passive income can consider transitioning from residential to commercial properties. One of the most effective ways to make this transition while deferring capital gains taxes is through a 1031 exchange. This strategy allows investors to reinvest proceeds from the sale of a residential property into a passive asset without immediately incurring tax liabilities. Many investment property owners enjoy this type of diversification option especially with such increasing landlord difficulties as local and state regulations, rent control and tenant friendly rights.
Why Transition from Active Residential to Passive Real Estate?
Properties – such as office buildings, retail centers, industrial warehouses and multifamily apartment complexes – can offer several advantages over residential rentals, including a higher income potential, portfolio diversification, a professional tenant base and arguably one of the most popular reasons – fewer hands-on management hassles. Since these types of assets often require larger amount of capital, investors can potentially benefit from a pooled capital model such as a Delaware Statutory Trust (DST).
How a 1031 Exchange Facilitates the Transition
A 1031 exchange, named after Section 1031 of the Internal Revenue Code, allows investors to defer capital gains taxes by reinvesting proceeds from a sold investment property (the relinquished property) into a new like-kind property (the replacement property). While “like-kind” may suggest similar property types, the IRS allows residential property owners to exchange into commercial real estate, making it an excellent tool for transitioning to larger, more potentially lucrative assets. Our team will work with you to dive deeper into the following topics. We’ll analyze your current investments and financial situations to help you make informed decisions and guide you through the entire process. We’ll also strategize to determine which investment option we can use to complete the exchange from a Delaware Statutory Trust (DST) to an UPREIT to a Triple Net Lease (NNN). Other options include and UPREIT, Opportunity Zones and more.
What we will do together:
Determine Your Investment Goals
Before initiating a 1031 exchange, let’s evaluate why you want to transition to a less hands-on real estate. Are you looking for greater cash flow, less hands-on management, estate planning or portfolio diversification? Understanding your objectives will help us identify the right replacement property or properties.
Sell the Residential Property
Once you decide to move forward, list your current residential investment property for sale. It could be a single-family rental, a duplex or a portfolio of small multifamily units. When you receive an offer, we’ll work with a qualified intermediary (QI)—a third party who facilitates 1031 exchanges and ensures compliance with IRS rules.
Identify a Replacement Property
The IRS requires that investors identify up to three potential replacement properties within 45 days of selling their relinquished property. The final selection must be acquired within 180 days from the sale date. Common properties for exchange include retail spaces (e.g., strip malls, standalone stores); office buildings (single-tenant or multi-tenant); industrial properties (warehouses, distribution centers); multifamily apartment buildings (5+ units); and self-storage facilities. We have an expansive list of available properties that are available now you can check out here.
Ensure the Exchange Meets IRS Requirements
To qualify for a tax deferral the transaction must meet certain criteria. The replacement property has to be of equal or greater value than the relinquished property; the entire sale proceeds must be reinvested; and the investor cannot receive “boot” (cash or non-like-kind property) without incurring some tax liability.
Close on the Replacement Property
Once due diligence is completed, we’ll work with your qualified intermediary, escrow and closing team to finalize the purchase within the 180-day window. Upon closing, you will defer capital gains tax while transitioning into a potentially higher-yielding commercial asset.
Challenges & Considerations
While a 1031 exchange offers tax advantages, transitioning to different real estate classifications can come with such challenges as larger capital requirement, market risks and the obvious learning curve (but we’re here to help you with that!) Set up an appointment or call with us to go over all your options.
Diversified Investment Strategies is a team of seasoned professionals specializing in 1031 tax-deferred exchange solutions, offering customized strategies and expert analysis to identify potentially suitable investments, including DSTs, UPREITs, opportunity zones, TICs, NNN properties and oil & gas royalties. With a proven track record of hundreds of successful exchanges, we empower our clients to make informed investment decisions. Contact us at www.diversified1031.com or 949-379-2080.
*Example portfolio is hypothetical and for illustrative purposes only. Individual results will vary and are not guaranteed. Because investor situations and objectives vary this information is not intended to indicate that an investment is appropriate for or is being recommended to any individual investor. This is for informational purposes only, does not constitute individual investment advice, and should not be relied upon as tax or legal advice. Please consult the appropriate professional regarding your individual circumstance. Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated. Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk. There are material risks associated with investing in private placements, Delaware Statutory Trusts (“DSTs”) and real estate securities including the potential loss of the entire investment principal, illiquidity, tenant vacancies impacting income and revenue, general and real estate market conditions, lack of operating history, interest rate risks, competition, including the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and investors should read the PPM carefully before investing paying special attention to the risk section. DST 1031 properties are only available to accredited investors (typically defined as having a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last two years; or have an active Series 7, Series 82, or Series 65). Individuals holding a Series 66 do not fall under this definition) and accredited entities only. If you are unsure if you are an accredited investor and/or an accredited entity, please verify with your CPA and Attorney. Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Diversified 1031 is independent of CIS.
FOR ACCREDITED INVESTOR USE ONLY.