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Opportunity Zones have the greatest potential for growth in the US real estate market. At Liquid, we strive to deliver the optimal combination of cashflow and portfolio appreciation.
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A 1031 exchange gets its name from Section 1031 of the U.S. Internal Revenue Code, which allows you to avoid paying capital gains taxes when you sell an investment property and reinvest the proceeds from the sale within certain time limits (45 days) in a property or properties of like kind and equal or greater value.
Are you a real estate investor considering a 1031 exchange? In the case of like-kind exchanges, Section 1031 of the tax code offers many capital gains tax advantages that can prove significant. However, in some cases, the 1031 may not be the only or the best option for deferring capital gains on the sale of real estate. Consider the following four 1031 exchange alternatives that may offer better returns than a 1031 exchange.
Delaware Statutory Trust (DST) real estate has been a great way for investors to participate in passive, professionally managed real estate for their 1031 exchanges since the IRS enacted Revenue Ruling 2004-86 which effectively blessed the use of a properly structured DST 1031 investment as “like kind” for the purposes of a 1031 exchange.
The DST investment structure of real estate ownership has given investors the potential to diversify* across several property sectors, geographic locations and with various managers. For those that wish to focus on areas of life like family, hobbies and travel instead of dealing with tenants or just having to be constantly concerned with the value of hands-on real estate and the best time to sell, DSTs can potentially be the right thing at the right time.
Qualified Opportunity Zone Funds are relatively recent investment vehicles whereby investors can place capital gains (within a certain timeline of selling) into real estate investments.
Generally speaking, they’re great investment options that offer the same benefits as that of the 1031 exchange. Through the Tax Cuts and Jobs Act, certain areas that have been mandated as Opportunity Zones according to the IRS as “an economically distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment.”
What this essentially means is that a qualified opportunity zone fund can invest in any real estate property that is located within a designated “opportunity zone” – an underserved area or one that needs economical uplifting. But there are a couple of critical points to consider in this type of investment vehicle. First and foremost, it may pose a risk as it entails investment in an area that needs development. Secondly the investment period may be lengthy which means that the capital may be typically held in this type of fund for a long duration, even 10 years.
It should be noted though, that Opportunity Zones are not necessarily used as a 1031 exchange, but rather another option in the case of a failed 1031 exchange or a potential tax-deferral tool for other investments with gains such as stock or the sale of a business.
Many investors that want to opt for a 1031 exchange investment option, but don’t want the hassle of day-to-day management, and/or want diversification–and with a working knowledge of Real Estate Investment Trusts (REITs) ask “why can’t I invest in these vehicles for my 1031 exchange?” Because of very specific guidelines for what is considered “like-kind” real estate, REITs are not eligible for 1031 exchange.
However, through an UPREIT transaction which stands for Umbrella Partnership Real Estate Investment Trust, it can potentially be possible through a series of steps. With a 721 exchange, instead of a 1031 exchange, investors may exchange property for OP or Operating Partnership units in the REIT. This might be easier said than done since the REIT would have to want to bring the relinquished property in and all parties would have to agree on terms, but it’s possible. Investors should also consider whether the REIT is public or private and the likelihood that they would have interest in conducting another tax-deferred exchange going forward since that would not be possible once this type of transaction has been made.
Which of these 1031 exchange alternatives appeal to you? Every case is specific, so it’s best to consult a professional who can recommend the best 1031 exchange options based on your unique situation.