Fractional 1031 Investment Benefits

Fractional 1031 Investment Benefits
Posted by on Jan 11, 2017

Example Property

Real estate investors contemplating a 1031 exchange must make many decisions regarding their choice of replacement property. Investors must determine the type of property, location of the asset, and whether or not to reinvest into multiple assets. Investors then have to thoroughly evaluate their options and select just a few potential choices -- all within 45 days from selling their investment property!

Because of this potentially daunting challenge, many exchange investors are turning to Replacement Property Interests™ in Delaware Statutory Trust (DST) or Tenants-in-Common (TIC) investments as an efficient exchange strategy. These “fractional” or “co-investment” investments may offer stabilized assets and professional property management. Additional benefits of Replacement Property Interests™ include:

  • 1031 Eligible
  • Timing
  • Pre-Packaged
  • Institutional-Grade Assets
  • Flexibility and Diversification

1031 Eligible

In order to qualify for a 1031 exchange, an investor must have direct ownership in a property. For instance, an individual taxpayer cannot do a 1031 exchange into a partnership, corporation, REIT or LLC that owns property as that is typically deemed an investment in an entity, not in direct property. Replacement Property Interests™, on the other hand, meet the direct investment requirement and therefore are a viable option for replacement properties. Although Replacement Property Interests™ are typically deemed securities under federal securities laws, they are treated as direct ownership of real estate under Section 1031 of the IRS tax code.

Timing

The biggest concern for many 1031 investors is meeting the IRS-imposed timeframes. An investor must find a suitable replacement property within 45 days of selling their relinquished property and complete the acquisition within the 180-day closing period. Closing can be delayed or fall through for a variety of reasons including physical or environmental concerns, financing or appraisal issues, etc. However, if a timeframe is missed for any reason, a 1031 investor risks disqualifying their entire exchange and may be subject to heavy tax consequences. By acquiring a Replacement Property Interest™ in a property which is has already been acquired by an investment sponsor, investors simply exchange funds for an ownership stake in the property, thereby eliminating the risk of failing to meet the timeframes for a valid 1031 exchange.

Pre-Packaged

In addition to already owning the asset, “fractional” 1031 investments are typically “pre-packaged” – meaning the sponsor of the investment has:

  • Expedited Due Diligence – Property inspections, environmental reports, rent rolls, financial statements, etc. have been procured and made available to potential investors.
  • Secured Debt - Mortgage financing is in place. Investors assume a proportionate share of the debt. The loan is typically non-recourse”, meaning the loan limits the lender’s remedies to the property itself and an investor’s assets outside the property are protected.
  • Retained Management - Professional property and asset management are provided by the sponsor or a third-party management company.

Institutional-Grade Assets

By exchanging into a Replacement Property Interest™ and pooling equity with other co-owners, an investor may be able to own a portion of an “institutional-grade” property that is significantly larger than the investor could achieve on their own. These larger-scale assets are potentially more stable, secure and liquid than alternatives available to an investor individually.

Flexibility and Diversification

Because these properties have already been acquired and pre-packaged, investors can evaluate their alternatives much more quickly and easily. Additionally, investors may purchase a Replacement Property Interest™ in the exact amount necessary to satisfy tax-deferred exchange requirements, eliminating any tax liabilities or providing the ability to invest any “boot” left over from another exchange.

Diversification is also more easily achievable. Since there is no limit on the number of Replacement Property Interests™ investors may exchange into, proceeds may be reinvested into several properties, allowing for diversification in property types and locations.

For many exchange investors, Replacement Property Interests™ can be an appealing alternative to acquiring a property on their own. It offers a combination of investment efficiency, stabilized properties, and flexible options all while ensuring compliance with IRS-imposed timeframes.

Visit the REALIZED Replacement Property Interest™ Marketplace for investment options in DSTs and TICs or learn more from the REALIZED Guidebook on Replacement Property Interests ™ in DSTs and TICs.

Topics: 1031 Exchange, 1031 Exchange Basics