Back to Insights  /  Read More About Estate Planning

Managing Your Real Estate Portfolio with Tax Efficiency

Tom Taranto, CFP®, AIF®


Highlights from the June 2021 webinar on 1031 and 721 real estate exchanges.

Presenters: Ben DiGirolamo, CPA, JD, Principal, Tax Advisory Group, HBK CPAs & Consultants; and Tom Taranto, CFP, AIF, Principal & Senior financial Advisor, HBKS Wealth Advisors

IRS Section 1031
Section 1031 of the IRS Code allows for realized gains to be deferred if the proceeds are used to buy like-kind properties. Section 1031, also known as the “like-kind exchange,” only applies to real property, not personal property. Under Section 1031 no gain or loss is recognized for tax purposes on the exchange of a property used for trade or business or held for investment purposes if it is exchanged solely for like-kind property, which is also to be held for productive use in trade or business or for investment purposes. The primary benefit is that gains on the sale of the property can be deferred.

The provision has been part of U.S. tax law for more than a hundred years.

Any real property held for investment or used in trade or business is eligible for exchange under Section 1031, including farmland; rental homes; oil and gas interests; commercial office buildings; a Delaware Statutory Trust (DST) interest; industrial and retail properties; common interest holdings; water, air, and mineral rights.

Some exclusions: personal property (was removed from eligibility by the Tax Cuts and Jobs Act), your personal residence; property held for sale; stocks and bonds; securities or evidence of indebtedness or interest; partnerships; certificates of trust.

Why do a 1031 exchange?
• You could face substantial tax consequences selling a property that has increased significantly in value while you owned it: a capital gains tax of up to 20 percent, a net investment tax of an additional 3.8 percent, and any applicable state taxes. With 1031, you can leverage the dollars you would have paid in taxes in your like-kind acquisition.
• You might be able to replace non-income producing property with income-producing property.
• For estate planning purposes

Rules for using a 1031 exchange include:
• The taxpayer/owner must use the services of a qualified intermediary, qualified trust, or qualified escrow account. The intermediary sits in the middle of the transaction, gets the cash then buys the like-kind property. The only exception is a true property swap.
• You can never touch the cash. The qualified intermediary does that. If you receive cash, you are disqualified from using a 1031.
• You must enter the exchange agreement on or before the date of transfer of the property being sold.
• You must identify in writing the potential property or properties that could be purchased with the proceeds of the sale of the relinquished property.
• You have 45 days after closing of the relinquished property to identify properties to buy and 180 days to complete the purchase/exchange.

Rules for identifying like-kind exchange properties:
• You can identify up to three properties of any value, or any number of properties if the combined market value does not exceed 200 percent of the relinquished property.
• You qualify if you identify more than three properties so long as you acquire 95 percent of the value of all properties identified.
• Identifications must be in writing and submitted to the qualified intermediary 45 days before the sale of the relinquished property.

“Boot” is anything in exchange that is not like-kind property.
The taxpayer will pay tax on “boot” up to the amount of gain. There can be a mortgage on either side of the transaction but if you’re paying off the mortgage with the proceeds and there is no mortgage of the same amount on the purchase side of the transaction, you will pay tax on the lesser of the boot or realized gain. You must recognize as gain any cash you take from the transaction.

Note: The accounting behind a 1031 exchange is rarely straightforward, on the buying or selling side; get your CPA involved from the beginning.

Delaware Statutory Trust (DST)
Without a like-kind exchange property in mind, you can use securitized real estate to facilitate a 1031 exchange. A DST, is a legal entity used to arrange for the co-ownership of property, is the most common form of securitized real estate used for 1031s. Through a DST, an investor can own fractional shares of real estate that qualifies for a 1031 exchange.

DSTs are available only to accredited investors, for which the rules are complicated, but generally require the individual to have a net worth of at least $1 million excluding their residence and an annual income of at least $200,000.

DST sponsors are experts in the various types of real estate managed and development. They specialize in their particular specialty areas, like multi-family housing or office buildings. DSTs are gaining wide acceptance in the marketplace.

Why exchange to a DST?
• To retire from being a landlord
• For a more diversified real estate investment
• For a new depreciation schedule if your property is fully depreciated
• To move to an income-producing property from non-income property
• To upgrade the quality of property you own
• To take advantage of current elevated real estate prices without the tax disadvantages
• To relocate your real estate holdings to a faster growth area
• If you’re approaching your 45-day 1031 exchange deadline and haven’t identified an exchange property

Advantages of a DST:
• A simple method for deferring taxable gains on a real estate asset
• Investment amounts as low as $100,000
* No credit checks; all bank financing at the DST level
• An easy way to own real estate: all property decisions outsourced to a professional real estate management company; ownership is 100 percent passive.
• Cash flow on a monthly basis and taxable income offset by depreciation
• Ongoing 1031 tax deferral: if the property is sold you can defer your share into a 1031 like-kind exchange.

Among the disadvantages of a DST:
• Limited liquidity: the decision to sell is solely at the discretion of the property sponsor; investors should consider a minimal five- to seven-year holding. However, most DSTs are arranged with 10 years of bank financing and are sold prior to the 10-year mark.
• No voting rights.

721 exchange
Another type of exchange: 721, or an “Upreit.” You do a 1031 exchange identified by a real estate investment trust (REIT) manager, then after two years in the 721 your investment gets absorbed by a REIT mutual fund.

A 721 provides a measure of safety in that you are investing in a diversified real estate portfolio, not a single property. But you only defer your capital gains as long as you own that REIT; you lose the deferral when you sell your REIT shares and further 1031 exchanges are not possible.

Why choose HBKS for your 1031 exchange?
• Access to the resources of one of the nation’s largest CPA and wealth management firms
• Experience with 1031 exchanges
• A multidisciplinary, holistic firm with broad expertise
• Additional due diligence from large investment holding companies
• Established relationship with a qualified intermediary

Why is now a good time to consider a 1031 exchange?
• Tax changes under consideration include eliminating 1031 deferrals for gains of more than $500,000.
• Tax changes under consideration include increasing capital gains tax rates for individuals with incomes in excess of $1 million to ordinary income tax rates.
• Tax changes under consideration include taxing unrealized gains on some types of property.


The information included in this document is for general, informational purposes only. It does not contain any investment advice and does not address any individual facts and circumstances. As such, it cannot be relied on as providing any investment advice. If you would like investment advice regarding your specific facts and circumstances, please contact a qualified financial advisor.

Any investment involves some degree of risk, and different types of investments involve varying degrees of risk, including loss of principal. It should not be assumed that future performance of any specific investment, strategy or allocation (including those recommended by HBKS® Wealth Advisors) will be profitable or equal the corresponding indicated or intended results or performance level(s). Past performance of any security, indices, strategy or allocation may not be indicative of future results.

The historical and current information as to rules, laws, guidelines or benefits contained in this document is a summary of information obtained from or prepared by other sources. It has not been independently verified, but was obtained from sources believed to be reliable. HBKS® Wealth Advisors does not guarantee the accuracy of this information and does not assume liability for any errors in information obtained from or prepared by these other sources.

HBKS® Wealth Advisors is not a legal or accounting firm, and does not render legal, accounting or tax advice. You should contact an attorney or CPA if you wish to receive legal, accounting or tax advice.

Speak to an Advisor

First Name*
Last Name*
Email Address*
Phone Number*