Many investors today have shifted their focus not only on financial returns but also on the broader impact of their investment strategies. That said, environmental, social, and governance (ESG) factors are increasingly influencing investment decisions for some. For those seeking to align ESG goals with real estate holdings, one potential avenue includes the use of 1031 exchanges.
How might like-kind exchanges contribute to ESG-aligned investment approaches? This guide from Realized 1031 explores where these two areas intersect and outlines considerations for incorporating ESG principles into exchange strategies.
A 1031 exchange allows investors to defer capital gains taxes by reinvesting proceeds from the sale of a relinquished property into a like-kind replacement property, subject to specific IRS rules. This tax-deferral mechanism can help preserve equity within the transaction.
Nevertheless, some investors pursue 1031 exchanges not only for the tax treatment but also for access to different asset types or structures, such as Delaware Statutory Trusts (DSTs), or to diversify into new markets.
The ESG movement refers to an investment approach that incorporates environmental, social, and governance factors into decision-making processes. ESG investing serves as a framework for investors seeking to evaluate assets and follow practices that are both financially sound and aligned with their values concerning environmental, social, and governance issues.
In real estate, ESG considerations are increasingly discussed due to the sector’s significant role in global energy use. For example, building operations are estimated to account for approximately 30% of global energy consumption. As a result, some investors explore ESG criteria in the real estate context to identify opportunities related to energy efficiency and sustainability practices.
How can 1031 exchanges support ESG-aligned investment objectives? Below are several approaches investors may consider:
One approach to incorporating ESG factors is acquiring a green building. These structures are LEED, ENERGY STAR, or WELL-certified thanks to certain components or integrations that allow them to reduce energy consumption. Some investors also view these certifications as indicators of potential operational efficiencies or enhancements to tenant experience.
You can also acquire replacement properties that, in some way, help support community development — examples are mixed-use buildings with affordable housing sections. Others may choose to invest in real estate that improves access to public infrastructures and services.
Investors can prioritize replacement properties operated by developers or REITs with a strong track record in governance practices, fair labor standards, and ethical compliance.
Unfortunately, pairing your ESG goals with a 1031 exchange is not always an easy task, and there are some challenges you may face along the way, such as the following.
1031 exchanges weren’t created for ESG investing, but they can be used as a vehicle to support investors in pursuing sustainability and values-based goals. From investing in green buildings to structures that support social development, the like-kind exchange may offer a way to create meaningful change while still deferring capital gains taxes. The inventory may still be low, but as ESG metrics become more standardized in the future, we may see more options that help you achieve purpose-driven investing.
The tax and estate planning information offered by the advisor is general in nature. It is provided for informational purposes only and should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.
Article written by: Story Amplify. Story Amplify is a marketing agency that offers services such as copywriting across industries, including financial services, real estate investment services, and miscellaneous small businesses.
Sources:
https://www.americanbar.org/groups/real_property_trust_estate/resources/real-estate/1031-exchange/
https://www.investopedia.com/terms/e/environmental-social-and-governance-esg-criteria.asp