NAMCOA, LLC RIA
Securities offered through MSC-BD, LLC
As we have reported all year the increase in 1031 Tax Deferred activity continues through the third quarter as more commercial real estate agents report. In the securitized world of real estate investing, the Sponsors and the Representatives of broker dealer (B/D) firms and Registered Investment Firms (RIA) have been sometimes overwhelmed with requests for replacement properties that can satisfy the requirements of the IRS 1031 Code. It is always prudent to review the requirements for a 1031 exchange. Simply put, there is a title requirement, a timing requirement, and a financial requirement.
Title. The investor on title needs to have the same taxpayer ID on both the sold or disposed property (occasionally referenced as the ‘down-leg’) as well as the replacement property or properties (referenced as the ‘up-leg’). Investors who are in partnerships with other investors need to seek advice on the needed qualifications to bifurcate the investment permitting one investor to move into a 1031 exchange if the other investors elect to seek their own exchange or simply sell their interest in the property. That would be a topic for another article to provide past investor strategies.
The timing requirements are under a tremendous amount of pressure this year as the real estate markets heated up for three quarters and continue to stay strong. Many real estate experts opine that the end of 2021 will continue to be very active. The biggest pressure point (or as one investor mentioned to me a choak hold) is the 45-day identification period. In the brick & mortar real estate arena this is heighten by the influx of cash coming into hard asset as some investors take profits from the stock market. Another good topic since real estate investment has been referenced to being ‘non correlated’ to the stock market. Back to the 45-day period, there is no extension to the 45 days period. Investors need to provide the Qualified Intermediary (QI) their final list by the end of the 45 days. During the 45 days the identification period the list may change as investors seek to negotiate contracts, prices, terms, and conditions as well as line up their financing if needed or required to purchase the new property. The next mandatory date is the closing date of the replacement property (up-leg) from the deposed property (down-leg) which is a maximin of 180 days. There are no extensions, period! If the contract for the replacement property (identified on the 45-day list) implodes, there are no substitutes if it is not on the list. Being able to secure a replacement property is vital for the success of the exchange.
The final aspect is financial requirement and there are three legs to that requirement. 1. The price of the new property must match or exceed the property sold; 2. All the cash proceeds from the sale (which must be held by a QI) needs to be used to avoid paying any capital gains taxes or recapture depreciation; 3. Replace the debt that was paid off on the property sold. The closing agent will send your net proceeds to the QI (you cannot take any possession of the funds or be subject to all the capital gain implications). Your QI will advise as to the amount of available cash you have to redeploy (after their fees & expenses for acquisition of the new property). One item which causes some confusion is the aspect of replacing the debt. This means if you had a mortgage or loan on the old property you need to replace that loan with a new loan or seller financing on the replacement property. The other alternative is to simply bring more cash to the transaction that adds up to the replacement value of the property sold.
So, what is the advice for the last two months of the year? If you have already closed on your down leg you need to secure your potential replacement properties and lock in. The Delaware Statutory Trust (DST) alternative may either provide the total solution or at least a back up for investors facing the end of the year dilemma. There is a surge in the DST interest and acquisition. DSTs provide a very easy solution for certain investors. The purchase may be scaled to satisfy to the penny the cash investment. In addition, many DSTs by design have non-recourse loans already built in to satisfy the debt replacement requirements. Skilled representative can also balance the overall financial needs of the investors. Since the DST are prepackaged closing on the acquisition may happen in a matter of a week or less. In some situation, when prudent, a diversified portfolio of DSTs may be suggested (for example two to three DSTs) to replace the one property that is being sold. Over the past year we assisted one investor selling four properties into a diversified portfolio of 16 DSTs. The diversification was both geographical as well as asset class.
Already we have investors who are positioning their real estate for sale in 2022 contacting us for strategies. Planning ahead on the potential replacement property may also ease the tensions of deciding to list your current investment. Once a real estate investor starts thinking about listing their property that is the time to read and become familiar with the 1031 process as well as the potential to utilize a DST as an alternative. The other suggestion is to know and understand your capital gain tax exposure. Your CPA or financial advisor may be of assistance. There would be tax on the capital gains on the proceeds on a federal level and potentially on a state level. Depending on how long you have owned the property there would be a tax on the recapture of the depreciation (on the property not the land). We do have tools on our website that may provide you with some insight. Please remember we are not providing tax advice.
DSTs are not for all investors. The acquisition of a DST is for accredited investors only. Contact your investment adviser for additional details on how a DST may be a solution to your 1031 Exchange and suited for your investment future. For more information on how to properly set up an IRC 1031Tax Deferred Exchange or if you are an accredited investor and would like additional information on a DST contact Al DiNicola at 239-691-8098 or email firstname.lastname@example.org.
This is not an offer to purchase or solicitation to purchase any security, as such be made only through an offering memorandum or prospectus. Investing in securities, real estate or any investment, whether public or private, involves risk, including but not limited to the potential of losing some or all of your investment dollars when you invest in securities. You should review any planned financial transactions that may have tax or legal implications with your personal tax or legal advisor. NAMCOA, LLC is a Registered Investment Advisor, regulated by SEC (Securities and Exchange Commission). Our corporate office is located at 999 Vanderbilt Beach Road, Suite 200, Naples Florida 34108. Securities Offered through MSC-BD, LLC, Member of FINRA/SIPC. 410 Peachtree Parkway Suite 4245, Cumming, GA 30041