You might be a real estate investor interested in using a 1031 Exchange to potentially defer capital gains taxes and depreciation recapture on property you want to sell. You might find a replacement property that meets your investment parameters through a crowdfunding platform.
The growth of online real estate crowdfunding platforms could allow you to participate in significant property investments at a lower investment cost.
What is Crowdfunding?
Through the crowdfunding process, you pool the gains generated from the disposition of your relinquished property with those of other investors to acquire fractional ownership of a replacement property. This could be through a Delaware Statutory Trust (DST) or similar structure that the IRS classifies as real property.
The same 1031 exchange steps apply with crowdfunding in play, with some tweaks:
- You sell your relinquished real estate property, and a Qualified Intermediary (QI) takes control of the proceeds. The platform might have a QI on staff to help with escrow, documentation, and deadlines.
- You have 45 days to identify a real estate investment on the crowdfunding platform. This must be of equal or greater value to the property you sell to fully defer taxes.
- Once you have identified a property in which you wish to acquire fractional ownership, you must document the details and submit them to the IRS.
- You have 180 days from selling your relinquished property to close on the replacement property you find on the platform.
Advantages of Crowdfunding a Like-Kind Exchange
Using a crowdfunding platform to find your replacement property can have many benefits, such as the following.
- Diversification. As a fractional owner, you could obtain ownership in multiple properties, spreading investment risk.
- Lower capital requirements. You could acquire larger, pricier commercial properties at a lower price point. Remember that in a 1031 exchange, you must invest all proceeds from the sale of your relinquished property to fully defer taxes.
- Professional management. Experienced professionals manage crowdfunded properties. This removes the property management burden from you.
Crowdfunding Caveats
While acquiring real estate with help from a crowdfunding platform can offer upside, it’s important to understand some of the limitations involved with this method:
- Illiquidity. Fractional ownership shares are generally illiquid. This means there is a limited secondary market for them if you decide to sell. As a result, you might not be able to sell your interest before the end of the investment term, which can be years.
- Platform reliability. Not all crowdfunding platforms are reliable or trustworthy. Before deciding to use one, you must perform due diligence to ensure that it has a good track record and an honest reputation.
- Compliance. While crowdfunding can be a way to find a replacement property, not all investments qualify under the IRS’ like-kind rules. Again, research is essential to ensure the replacement property meets specific requirements.
A Different Source
Using a crowdfunding platform can be a viable way to target potential replacement properties as part of the 1031 exchange process. This method can help reduce investment price points and increase your portfolio’s diversification.
However, a crowdfunding platform has many issues. Research and consulting with trusted tax advisors, real estate attorneys, and other professionals can help determine whether crowdfunding and fractional ownership are viable strategies.
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.