What to Know About Tax Deferrals for Investment Properties

Simply put, tax reforms and other changes affect the amount taxed on profits from commercial real estate properties. So, it’s important to be aware of any tax savings that may be pulled from the sale of a property to gain more control over hefty capital gains. 

Tax burdens may be minimized through some routes such as 1031 Exchanges or a Delaware Statutory Trust. Of course, the purpose of tax-deferred exchanges such as these is to allow for a significant gain without the tax penalty. 

Let’s explore the details.

Note: These tax-saving mechanisms may vary from state or county, so investors should be mindful of any applicable regulations that are state- or county-specific to the property.

1031 Exchange

Perhaps one of the most commonly known tax deferral strategies, a 1031 Exchange involves an investor selling a property and then reinvesting the proceeds on a like-kind property that complies to certain criteria. When done correctly, the investor avoids being taxed on the gains. 

Specifics:

• It applies only to investment properties of equal or greater value.
• Foreign property is not a viable candidate.
• The strict timing rules to qualify include being identified within 45 days of closing and must close within 180 days or by the taxpayer’s return deadline (whichever is earlier). 
  • Tip: If a 1031 Exchange is performed toward the end of the year, it may be advantageous to request an extension on the taxpayer’s return.

Delaware Statutory Trust (DST)

The use of Delaware Statutory Trusts is not a new concept, but depending on the current tax laws, they may become a preferred investment vehicle for passive 1031 Exchange investors and direct/non-1031 Exchange investors alike. This is due to DSTs’ typical structure of not being subject to tax at the business organization level.

Specifics: 

• DSTs don’t need to occur in Delaware to be legally recognized as trusts set up for the purpose of business.
• It is derived from Delaware Statutory Law as a separate legal trust, qualifying it under IRS Section 1031 as a tax-deferred exchange.
• It permits owning 100% of the fee simple interest and may allow up to 100 investors (sometimes more) to participate as owners of the property.

Tenancy-in-Common (TIC)

The tenancy-in-common type of ownership allows individual investors to pool funds, secure more financing, and have ownership interests without the burden of property management. 

Specifics:

• Each investor or co-owner holds an undivided, fractional interest. 
• TIC is accepted as a form of direct ownership, so it may be 1031 Exchange-eligible.
• There is a maximum of 35 investors total.
• Unlike in a DST, investors receive the property deed and typically form a single-member limited liability company (LLC).
• Also differing from a DST, investors have equal voting rights and unanimous approval. 

Opportunity Zones

The origin of opportunity zones is it was introduced for economically disadvantaged areas across the U.S. through the use of tax cuts and the Jobs Act of 2017. 

Specifics:

• Once a property is sold, the investor must reinvest the gains within 180 days into a qualified fund that invests in opportunity zone properties specifically. 
• To reap the tax benefits, investors are required to keep funds in the investment for a minimum of five years.
• To qualify for the tax break, there must be a significant amount of capital gains (money from other sources would not be acceptable).

Investment Property Example:

Single-tenant net lease for especially essential retail properties continue to be considered a stable investment. In 2019, 44 percent of STNL buyers participated in a 1031 Exchange. Oftentimes, this tax-deferred strategy serves as a gateway for typically non-retail investors into the arena. 

>>  Interested in a 1031 Exchange? See What Properties We Have Available Now >>

When it comes to investment properties, you will want to stay apprised of any strategies that may help minimize your tax penalty at the end of the year. So, keep these items at top of mind when it comes to more control over capital gains. 

This article is intended for informational purposes only and should not be used as a substitute for recommendations or services provided by a licensed professional.