Tax Deferred Exchange and Investments in REITs

Real estate investors frequently ask the question “Can I do a 1031 exchange of the relinquished property proceeds into a REIT (Real Estate Investment Trust) as replacement property?” REITs are entities that own and manage portfolios of real estate that are typically diversified by industry, geography and tenant and there are many features to REITs, including professional management, diversification and the potential for current monthly dividends and stock growth. However, 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 seeking 1031 exchange tax deferral must exchange property that is considered “like-kind” property which means exchanging real property held for investment or business purposes for other real property held in the same manner. REIT shares are not like-kind to real property.

 

A New Replacement Property Strategy For Investors
However, although investors cannot perform a 1031 exchange into a REIT, there is a creative two-step approach that can allow investors to essentially own the equivalent of shares in a REIT.

 

Step #1 -1031 Exchange into a DST: An investor exchanges into a Delaware Statutory Trust (DST) that offers the potential to do an UPREIT pursuant to IRC §721 at a later point in time into operating partnership units (OP Units) in a REIT. A DST is a structure that offers fractional ownership of real property and qualifies for tax deferral. A DST has many benefits including the ability for investors to exchange out of actively managed real property and into a passive investment in a fractional ownership of institutional grade replacement property with high quality commercial tenants.

 

Step #2 - UPREIT from the DST into OP Units of a REIT: The investor utilizes IRC §721 and performs an UPREIT from their DST shares into operating partnership units (OP Units) in a REIT. The OP Units typically 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. Generally the investor is able to maintain tax deferral as long as the OP units are held. If the REIT shares are publicly traded, shares can be sold on the open market for cash. Conversion of OP units to REIT shares by the owner does create a taxable event, however, investors may choose to stagger those conversions for liquidity and tax management purposes. In addition, upon an OP Unit holder’s death, the beneficiaries of the OP Units will receive a stepped-up basis in the OP Units, similar to real estate, thereby providing greater tax planning flexibility.

 

Tax Benefits

This website does not constitute an offer to sell or a solicitation of an offer to buy any security that may be referenced on or through this website. Offers can only be made through the Private Placement Memorandum which contains various and important risk disclosures. All information should be viewed in conjunction with the Private Placement Memorandum. An investment of this sort is speculative and involves a high degree of risk. Projections of future performance contained herein are based on specific assumptions discussed more fully in the Private Placement Memorandum and do not constitute a guaranty of future performance.

DST Interests in any of the properties displayed on this website may be sold only to "accredited investors," as defined in Regulation D under the U.S. Securities Act of 1933, as amended (the "Securities Act"), which, for natural persons, refers to investors who meet certain minimum annual income or net worth thresholds. Offers and sales of DST interests have not and will not be registered under the Securities Act or the laws of any U.S. state or non-U.S. jurisdiction and may be offered only pursuant to an exemption from such registration. Neither the U.S. Securities and Exchange Commission nor any other regulatory authority has passed upon the merits of an investment in the DST Interests, has approved or disapproved of DST Interests or passed upon the accuracy or adequacy of this website and any supplementary materials describing the DST Interests. DST Interests are also not subject to the protections of the Investment Company Act of 1940, including the limitations on self-dealing, affiliated transactions and leverage contained therein. DST Interests are subject to legal restrictions on transfer and resale in accordance with the governing documents of the Trust and applicable securities laws, and investors may be unable to sell or transfer their DST interests. In addition, there is no public market for the DST interests and no such market is expected to develop in the future. Investing in the DST securities involves risk, and investors should be able to bear the loss of their investment.