Astute investors increasingly leverage a powerful tax deferral strategy known as the 1031 exchange. This provision, found in section 1031 of the Internal Revenue Code, enables real estate investors to defer their capital gains taxes when selling an investment property as long as they reinvest the proceeds into a like-kind replacement property.
Yet, many investors might not realize that their replacement property options extend beyond traditional ownership. Many may wonder about the potential for exchanging into options such as real estate investment trusts (REITs)
In this article, we’ll delve into whether 1031 exchange real estate investment trusts are possible and alternative options, providing insights to help you determine which route aligns with your objectives for a 1031 exchange.
1031 Exchange Real Estate Investment Trusts
In theory, a 1031 exchange real estate investment trust involves the process of selling an investment property and exchanging it into a REIT. REITs are autonomous companies that own, operate, or finance income-generating real estate. They typically allow individual investors to invest in real estate assets without having to purchase, manage, or finance properties themselves.
This approach allows investors to tap into diverse real estate opportunities, including commercial properties, multifamily dwellings, healthcare facilities, hotels, and other sizable ventures. These are ventures that they might not have had the resources or bandwidth to acquire and oversee independently.
To qualify as a REIT, a company must meet explicit criteria set forth by tax authorities. These criteria typically include1:
- Be managed by a board of directors or trustees.
- Have shares that are fully transferable.
- Have a minimum of 100 shareholders after its first year as a REIT.
- Invest at least 75% of its total assets in real estate assets and cash;
- Derive at least 75% of its gross income from real estate-related sources, including rents from real property and interest on mortgages financing real property.
- Derive at least 95% of its gross income from such real estate sources and dividends or interest from any source.
- Have no more than 25% of its assets consist of non-qualifying securities or stock in taxable REIT subsidiaries.
- Payout 90% of its annual taxable income as dividends.
REITs are structured similarly to a corporation and are also typically registered with the SEC and traded on public stock exchanges, providing investors with liquidity and the ability to buy and sell shares.
Can I 1031 Exchange into a Real Estate Investment Trust?
Since REITs involve investing in real estate assets, one may assume that you could use a 1031 exchange to acquire shares of a REIT. Unfortunately, you cannot 1031 exchange into a real estate investment trust, at least not directly. The inability to do so is due to the IRS not considering REITs as like-kind real estate.
However, there is an alternative path to exchanging into a REIT. This can be accomplished by completing a 1031 exchange into a DST and then initiating a 721 UPREIT exchange from the DST into the REIT. It’s worth noting that this is an extremely complicated process and requires thoughtful planning and the enlistment of professional tax counsel.
What are My Other Options?
If you find it disappointing that direct exchanges into REITs aren’t possible, know that alternative avenues are available. Some of these alternatives offer comparable benefits to REITs, providing you with similar advantages.
Like any investment, REITs and these alternative options must be carefully considered based on the investor’s financial goals, risk tolerance, and investment preferences. Always consult a tax professional or financial advisor.
If REITs sounded appealing due to the passive nature of income and the deferral of management responsibilities, Canyon View Capital may be able to offer a solution for your 1031 exchange through an alternative method.
Canyon View Capital Offers Unique 1031 Exchange Opportunities
While 1031 exchange real estate investment trusts are not viable without going through complex workarounds, there are ways to use a 1031 exchange to gain access to similar benefits.
At CVC, we take pride in overseeing a diverse portfolio of multifamily properties across the Midsouth and Midwest regions. Exchanging into one or more of these properties as Tenants in Common allows you to experience perks akin to REITs. This includes passive income from real estate without the burden of property management, all while simplifying your 1031 exchange process with accessible replacement options.
With over 40 years of experience in real estate between our principles, we’re deeply passionate about multifamily real estate investing. Our aim is to leverage this extensive expertise to assist you in completing your 1031 exchange seamlessly, providing you with convenient replacement choices along the way.
Still need more information on the best 1031 exchange investments?
For over 40 years, the principals at Canyon View Capital have worked in real estate, with a portfolio currently valued at over $1B2. Our buy-and-hold strategy, concentrated in America’s heartland, is designed to provide consistent investment returns.
1Office of Investor Education and Advocacy, “Investor Bulletin: Real Estate Investment Trusts (REITs),” for SEC. Jan. 2011, SEC.gov. Accessed March 14, 2024.
2$1B figure based on aggregate value of all CVC-managed real estate investments valued as of March 31, 2023.
Gary Rauscher, President
When Gary joined CVC in 2007, he brought more than a decade of in-depth accounting and tax experience, first as a CPA, and later as the CFO for a venture capital fund. As President, Gary manages all property refinances, acquisitions, and dispositions. He works directly with banks, brokers, attorneys, and lenders to ensure a successful close for each CVC property. His knowledge of our funds’ complexity makes him a respected executive sounding board and an invaluable financial advisor.
