Many real estate investors are familiar with 1031 exchanges and how they can use them to their advantage to maximize gains when selling and purchasing investment property. By deferring capital gains (15%) and depreciation recapture (25%) taxes on their sale, investors can greatly increase their buying power for the purchase of the replacement property. While holding investment/income producing property can be very profitable, it can also become very tedious work. Maintaining the property, collecting rents, or making repairs or upgrades can become quite the imposition on an investor particularly if they own multiple properties. Rather than deal with all of these issues if and when they arise, some investors would prefer to hold investments which allow them to be passive investors. One issue that prevents investors from accomplishing this is that once an exchange property is sold without completing another 1031 exchange, some or all of the deferred taxes will then be owed. This can be particularly important for investors that have done multiple 1031 exchanges stemming from one original property.
Fortunately, there is an option that allows real estate investors who have utilized 1031 exchanges to move to a more passive investment option. This investment strategy, called a 1031/721 exchange into a Delaware Statutory Trust (DST), allows previous 1031 exchangers to sell property as part of a 1031 exchange and purchase an interest in these Delaware Statutory Trusts. A 721 exchange is the back end of this strategy which allows the investor to move into the DST while still maintaining the tax deferred status of their 1031 exchange. DSTs are trusts established under Delaware law where each owner (investor) holds a “beneficial interest” in the trust and is treated as if they own a fractional interest in the property that the trust owns. In 2004 the IRS released Ruling 2004-86, which stated that the fractional ownership provided by the DST qualified as “like-kind” property to real estate for the purposes of a 1031 exchange. The use of a 1031/721 exchange into a DST can be very useful for those investors that wish to move to a more passive investment portfolio than they had owned previously with their 1031 exchange property.
Midland 1031 is a qualified intermediary with Certified Exchange Specialists® on staff to assist you in navigating the complexities of exchanges, ensuring your transactions are performed in compliance with regulations. Contact us for more information on how you can manage your real estate investments to avoid paying taxes using 1031 and other exchange options.