Completing a 1031 exchange can provide real estate investors the opportunity to defer taxes today and plan accordingly so they can avoid burdening their heirs with a hefty tax bill later.

A 1031 exchange involves selling a piece of investment real estate and reinvesting the proceeds in a like-kind real estate investment of equal or greater value, to ultimately defer capital gains and depreciation recapture taxes.

The possible tax benefits that the 1031 exchange may offer, in combination with the option to divide assets appropriately to benefit heirs down the line, make 1031 exchanges an estate planning strategy worth considering.

Step-up in cost basis

While there are reasons a real estate investor would want to sell a property in a standard transaction and pay the required taxes, this path could cost the investor upwards of 30-40% of the profits which go to straight to the IRS.

In a 1031 exchange, taxes on the gains on the relinquished property are deferred. Upon the owner's death, neither the estate nor beneficiaries face a tax liability. Instead, the tax basis for the real estate investment that heirs inherit steps up to the fair market value of date of death when they take possession. If they decide to sell the asset immediately, they will not owe capital gains taxes. They also will not be responsible for any of the depreciation recapture from which you may have benefited over the lifetime of your investment.

If the heirs wish to retain the asset, they would only be liable for taxes on gains in the future that accumulated as of the date they received the step up, up until when they sell the property. They might even consider including the property in a future 1031 exchange to defer taxes and reinvest the proceeds, to defer that gain too.

Swap ‘til you drop

When investing in real estate, the properties you currently own may not be aligned with your investment objectives down the road.

It is possible to enhance your real estate portfolio over time, and through 1031 exchanges, defer the taxes each time. There is no limit to the number of 1031 exchanges an investor can complete. Investors can “swap until they drop” so long as each transaction's intent is for long-term investment rather than solely tax avoidance.

It is an opportunity to keep your own investment goals as the priority and use previous growth to have further compounded growth, while also positioning your portfolio to benefit your heirs. 

When there are multiple heirs

For investors who plan to leave assets to multiple heirs, it is possible to consider their financial situations when structuring your 1031 exchange.

As part of the exchange, investors may purchase multiple, or in some cases, an unlimited number of properties, setting the stage to leave different assets to different heirs. For example, let us suppose one heir will likely need to sell the investment after taking possession while another might want to hold the asset. In that case, it is possible to make it easy for both by purchasing multiple properties and listing each heir as a beneficiary of an individual asset.

Keep in mind that replacement properties must be identified within 45 calendar days after selling the relinquished property. It is viable to identify up to three replacement properties. Still, that limit can be surpassed so long as the replacement properties' value does not exceed 200% of the relinquished property, or the investor closes on at least 95% of the value of the replacement properties identified.

Consider a Delaware Statutory Trust (DST)

A Delaware Statutory Trust is a long-term passive real estate investment in which beneficial interests of a real estate trust are owned rather than individual properties directly.

DST’s provide benefits for an investor's current situation by eliminating the headaches that come with active management properties, while still obtaining all of the benefits of real estate ownership. 

When it comes to estate planning, DST interests can be split among heirs, either ahead of time when purchasing the interests through the purchase of multiple of the same DST, or upon death via reregistration based on instructions of Will’s or Entity documentation. This streamlines decisions, while defusing potential estate conflicts. Investors should be aware that DST’s are typically designed to last five to ten years, and there is no active secondary market for investors should they need to sell.

1031 exchanges offer benefits for individuals looking to maximize their real estate investments today while setting up beneficiaries to continue building wealth. We always recommend consulting your tax or financial professional regarding how 1031 exchanges may fit your situation. 

To learn more, please contact us at any time.

For more insight and details about how a DST may fit within your investment portfolio, download our latest Ebook, The ABCs of DSTs.

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There are material risks associated with investing in DST properties and real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, 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 potential loss of the entire investment principal. Past performance is not a guarantee of future results. Potential cash flow, returns and appreciation are not guaranteed. IRC Section 1031 is a complex tax concept; consult your legal or tax professional regarding the specifics of your particular situation. This is not a solicitation or an offer to sell any securities. DST 1031 properties are only available to accredited investors (typically have a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last three years) 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.

This is for informational purposes only and is not an offer to buy/sell an investment. There are risks associated with investing in Delaware Statutory Trust (DST) and real estate investment properties including, but not limited to, loss of entire principal, declining market value, tenant vacancies and illiquidity. Diversification does not guarantee profits or guarantee protection against losses. Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated. Because investors situations and objectives vary this information is not intended to indicate suitability for any particular investor. This information is not meant to be interpreted as tax or legal advice. Please speak with your legal and tax advisors for guidance regarding your particular situation.

Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Advisory services offered through Concorde Asset Management, LLC (CAM), an SEC registered investment adviser. Insurance products offered through Concorde Insurance Agency, Inc. (CIA) Fortitude Investment Group is independent of CIS, CAM, and CIA.

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