What is a 1031 Exchange? 

The 1031 exchange process allows landlords to defer capital gains taxes by exchanging one property for another of equal or greater value.

Some of the key points to having a successful tax-free 1031 exchange include: 

• You must have a Qualified Intermediary (a disinterested third party to hold onto your proceeds from your sale of investment property). This cannot be your closing attorney or investment advisor, and you must never have the proceeds from your sale.
• You have 45 days to identify a replacement property.
• The IRS must consider the replacement property like-kind (property held for business use, which can collect rental income). So, you don’t need to buy farmland just because you own farmland. It can be exchanged into multifamily or industrial property.
• You have 180 days to complete the purchase.
• The total value of the purchased real estate ( DST/investment property or combination of the two) must be greater than or equal to the real estate you sold.
• If you paid off a real estate loan, you must replace it with a new loan equal to or greater in value. If you do not replace this debt amount, you would need to come out of pocket and use additional cash to ensure you have a 1031 exchange that eliminates the taxes.

How can I protect myself from the high 1031 Exchange failure rate?

According to the Echelon Business Development Network, more than 60% of 1031 exchanges fail. This failure rate could be even higher in areas such as NJ or the NYC Metro Area, where environmental concerns are more closely scrutinized, and litigation may be more prevalent.

A 1031 Exchange can fail due to the inability to close on the replacement property within your 180-day allowance, often caused by an environmental concern, permit delay, or disagreements. One of the best perks available in the IRS tax code is that you are allowed to have a backup replacement property, which can help mitigate this issue. Under the 1031 exchange rules, your replacement and backup properties must be identified in your 45-day window.

Delaware Statutory Trusts are an excellent backup since they can be purchased easily and quickly. Suppose a Delaware Statutory Trust isn’t your primary goal, but you need it for a backup. In that case, the good news is that once your Delaware Trust is Sold in the future, you can do another 1031 exchange back into property that you directly manage. This is just one of the benefits of owning a Delaware Statutory Trust. 

Marc Alan Wealth Management talked to a prospective client who had identified three properties for a 1031 exchange. Unfortunately, their primary acquisition target fell through, and the other two properties became unavailable. Had this person used a DST as a backup, they would have saved millions in taxes. DSTs are a great backup replacement property since you can acquire one easily, and the process can take less than a week. There are many more benefits to consider.

>>DSTs offer many benefits to real estate investors; read about them here.

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