Unlock the Door to REIT Investments With a 1031 Exchange

Wondering if you can sell your investment property and invest in a Real Estate Investment Trust (REIT) through a 1031 exchange? The answer is yes, but the process is complex and requires specific steps. Some real estate experts may argue that it's not possible as the nature of real property and REIT investments are different.

However, with a bit of planning and understanding of 1031 exchanges and REITs, it is possible to make the transition. Learn how to navigate the complex path and make your investment property to REIT transition a success.

Understanding the Differences: Real Property vs Securities

When you sell an investment property, you're disposing of a physical asset that the IRS classifies as "real property." The Internal Revenue Code Section 1031 allows investors to exchange these properties for similar assets, or “like kind”, held for investment or business purposes. This can be done to defer capital gains taxes, as long as the proceeds from the sale of the original property are reinvested in one or more similar properties within a specific time frame. This process is commonly known as a 1031 exchange.

A Real Estate Investment Trust (REIT) operates in a different way, however. REITs invest in real estate properties and hold them in a portfolio. Instead of buying the properties themselves, investors buy shares in the REIT. The cash flow generated by REITs comes from dividends, rather than rental income.

Since REITs are considered securities, they cannot be considered "like-kind" assets under the 1031 exchange regulations. That's why it's not possible to directly exchange your investment property for REIT shares. However, there are still ways to complete a 1031 exchange into a REIT, but they require a bit more planning and complexity.


Explore the Option of Transitioning from Property Ownership to REIT Investment through a Delaware Statutory Trust (DST) and UPREIT Conversion.

If you're considering investing in a REIT, one way to do it is through fractional ownership of a DST and subsequent conversion into an Umbrella Partnership Real Estate Investment Trust (UPREIT). Many REITs offer this option, where DST investors can convert their interests into Operating Partnership (OP) units. This conversion is done through a partnership which enables you to defer capital gains taxes, unless you decide to convert your UPREIT OP units into REIT shares later on.

It's important to consider that this type of exchange may have advantages and drawbacks. Potential benefits could include:

●     Offers liquidity opportunities by allowing conversion of UPREIT OP units into REIT shares, albeit with a taxable event

●     Provides diversification options to help balance out economic volatility by creating a portfolio of assets

●     Facilitates efficient estate planning by potentially enabling transfer of UPREIT OP units to heirs with potential elimination of capital gains taxes(unless converted to REIT shares)

An important aspect to keep in mind when considering UPREIT conversion is that it marks the end of the 1031 exchange process. It's not possible to exchange UPREIT OP units back into real property, In order to maintain the deferral of capital gains taxes, your investment must remain in the form of UPREIT OP units.

Understanding the Process

Here's a step-by-step breakdown of the UPREIT process from the perspectives of both the sponsor and the investor:

●     The sponsor typically places an institutional-grade asset, whether from a REIT or a new acquisition, into a newly formed Delaware Statutory Trust (DST).

●     During the syndication period, the DST offers 1031 exchange and other investors a predetermined amount of equity. Investors acquire beneficial interests in the trust and begin earning distributions similar to a standard DST investment.

●     After a hold period of typically two to three years, which satisfies the IRS safe-harbor guidelines for investment properties, the sponsor executes a Section 721 UPREIT on the property held under trust.

●     Investors then exchange their DST beneficial interests for operating partnership (OP) units in an entity that's owned by the REIT.

●     After a predetermined lockout period, investors have the option to redeem their OP units for common stock in the REIT or for cash, subject to the terms laid out by the REIT.

The Final Word:

Exit strategies can be challenging for real property and DST investors. The UPREIT structure provides an opportunity to achieve greater liquidity and diversification of portfolio, but the process can be lengthy and complicated. Additionally, the loss of the ability to defer capital gains tax liabilities through 1031 exchanges may not be worth it for some investors. It's recommended to seek guidance from an expert with knowledge of DSTs, UPREITs and REITs before making a decision to divest real property assets for shares in a REIT.

During syndication, DST provides 1031 exchange investors and others with a set amount of equity. They obtain a beneficial interest in the trust and begin receiving distributions similar to other DST investments. After a few years, the sponsor executes a Section 721 UPREIT on the property, and the investors exchange their DST beneficial interests for OP units owned by the REIT.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. Information herein is provided for information purposes only and should not be relied upon to make an investment decision. All investing involves risk of loss of some, or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

1031 Risk Disclosure:

Alternative Investment Funds for Cash Investors

Investors today face a difficult market. Interest rates at conventional banks are extremely low. The stock market trades at record highs one day before falling the next as a result of persistent volatility. Understandably, some investors become anxious as the stock market swings back and forth. So what are some alternative investment options for cash investors?

The question of where to turn next arises for cash investors trying to diversify their holdings. Unsure of what to do, some people choose to take no action. According to some estimates, $14 trillion is currently lying in money market accounts earning next to nothing. Better options must exist, and they do.

This article examines macroeconomic investing trends as well as some of the various investment options available to people looking to diversify their portfolios using real estate.

Trends in the Market Today

The average return on high-yield bonds was just 3.32 percent between 2011 and 2020. (source: Morningstar Direct, Standard & Poors, Yahoo Finance, Federal Reserve Economic Data). In comparison to investment grade bonds, Treasury bonds, and Treasury bills, which generated average returns of 1.42%, 0.92%, and 0.09%, respectively, during this period, high-yield bonds are typically seen as one of the "better" investments. In conclusion, even the bonds with the best performance over the past ten years hardly kept up with inflation.

By making stock market investments, investors haven't done any better. Over the previous 20 years, the average yearly fall in stocks was 16%. (source: Morningstar Direct, S&P 500 maximum drawdowns by year).

Typically, 60% of an investing portfolio is made up of stocks and 40% of bonds. Therefore, it seems sense that investors would want to diversify their holdings. One method to achieve this is by making institutional-quality real estate investments.

Various Investments

An alternative is to put money into a syndicate or fund for commercial real estate. For instance, Delaware Statutory Trusts permit accredited individuals to invest alongside many others in institutional-quality real estate. As a result, the entry barrier is lowered and direct ownership is made possible, with an experienced third-party sponsor managing and supervising the property in all other respects.

Investments in funds, syndications, and DSTs, however, are frequently illiquid. Depending on the planned business plan and hold time, this may require an investor to commit their funds for a period of three to seven years or longer. If they are interested in adding real estate to their portfolios, those who want to preserve additional liquidity opportunities have a few different options.

Periodic Funds

A type of closed-end fund known as an interval fund provides investors with liquidity at predetermined intervals, usually quarterly, semi-annually, or yearly. This implies that shareholders may periodically sell a portion of their shares at a price determined by the net asset value of the fund. Investors may not always be able to sell their shares during a specific redemption period. As a result, interval funds should normally be viewed as long-term investments; yet, they will typically charge a premium for illiquidity.

Real estate is just one of the various assets and asset classes that may be purchased with interval funds. A single interval fund is not constrained to investing in a single asset class; rather, they can do so to diversify their holdings by purchasing a variety of assets.

Trusts that invest in real estate

Real estate investment trusts, or REITs, are businesses that hold and/or manage commercial real estate that generates income. REITs come in a variety of forms. The majority will concentrate on a certain product category (such as retail, hospitality, multifamily housing, senior living facilities, student housing, office, self-storage, industrial, and similar) or geographic area (e.g., commercial real estate in the Northeast vs. Southwest).

A person purchases a share in a REIT when they want to invest in a business that owns and operates rental properties. Shares of publicly traded REITs can be bought and sold just like other equities, even on a daily basis, giving investors a lot of liquidity.

REITs frequently have precise investing criteria. They then make investments in properties that fit such criteria. REITs are obligated by law to distribute 90% of their income as dividends to shareholders.


Funds for Other Income

Investment funds come in dozens, if not hundreds or thousands, of distinct varieties. These include hedge funds, money market funds, mutual funds, bond funds, and equity funds. Through one of these kinds of funds, many investors have started making real estate investments.

A specific type of funds known as a real estate income fund is dedicated solely to real estate investments that provide income. Those wishing to invest cash in sizable commercial real estate portfolios have another entry point in real estate income funds. Retail investors who want to acquire institutional-quality real estate that is otherwise out of their price range find real estate income funds particularly intriguing. A real estate income fund pools money from numerous investors, and its sponsor then manages every aspect of the fund's operations, from due diligence and underwriting to property repairs, stabilization, continuous management, and ultimately sale. A real estate income fund may have various investment minimums and lengthy hold periods depending on its structure; as a result, the invested capital should be regarded as illiquid throughout that hold period.

Examples of Funds Perch Wealth Offers

Perch Wealth offers a number of vehicles for cash investors wishing to diversify their portfolios away from conventional stocks, bonds, and shares. While it is well recognized for its DST services. Here is a list of some of the income funds that Perch Wealth currently offers:

Essential Income Fund for ExchangeRight

A REIT with 254 recognized single-tenant, net-leased properties spread throughout 196 markets and 29 states is called the ExchangeRight Essential Income Fund. Investment-grade and generally recession-resistant tenants like Dollar General, Family Dollar, Walgreens, CVS Pharmacy, Tractor Supply, Hobby Lobby, and Walmart Neighborhood Market were the focus of this $531 million deal. The nature of these enterprises has historically placed them particularly positioned to weather economic uncertainties and periods of economic slump, as seen during the Great Recession and again during the COVID-19 epidemic. Although retail has usually struggled in recent years, Additionally, the portfolio aims to safeguard against inflation by offering the possibility of increasing cash flow distributions supported by long-term leases that guarantee portfolio rent increases during both the primary and option lease periods.

If funds are available, this REIT will make 100% tax-deferred distributions on a monthly basis. This is a great choice for cash investors wishing to add real estate to their portfolios while still maintaining liquidity because the investment requirement is only $25,000.

Trust for VineBrook Homes

The increased demand for single-family rental (SFR) housing is something that VineBrook Homes Trust (VHT) hopes to take advantage of. The fund aims to make investments in workforce housing with modest rents. This tactic depicts how slowly entry-level new homes are built. Less than 9% of newly built homes are currently priced at $200,000 or less. Due to this, many people now have little alternative but to rent as home ownership grows more and more out of reach. From 4,200 units in Q4 2018 to nearly 13,700 SFR homes in Q1 2021, VHT has increased the number of SFRs in its portfolio. The ownership team uses a value-add strategy to upgrade the properties' condition, luring renters prepared to pay top dollar to them. The portfolio has a stabilized occupancy rate of 98.7% and an average rent of $1,044 per house with a typical size of 1,320 square feet.

This REIT is a partnership between NexPoint, which has a multibillion dollar investment platform and extensive value-add knowledge, and VineBrook, whose operators have been managing SFRs since 2007.

VHT is a $1 billion offering with a $50,000 minimum investment for accredited investors. If funds are available, accrued dividends are expected to be made on a monthly or quarterly basis and will be tax-deferred with growth potential. For those looking to invest in a real estate product type that is in high demand, VHT may be a great choice.

Preferred Shares of Bluerock

Investors seeking to invest largely in institutional-quality Class A apartment buildings might think about buying Bluerock Series T Redeemable Preferred Stock. These are shares of the publicly traded Bluerock Residential Growth (BRG) REIT, which owns a variety of extraordinarily high-quality live-work-play apartment communities in some of the top growth markets in the country.

With a low $5,000 investment requirement, Bluerock Preferred Stocks are being offered for as little as $25 per share. If funds are available, the REIT is expected to pay dividends every month.

These redeemable preferred shares offer investors liquidity right now because BRG is a NYSE-listed REIT.

Trust for Cantor Fitzgerald Income

A publicly listed, non-traded REIT, Cantor Fitzgerald Income Trust (CF Income Trust), invests at least 80% of its funds in multifamily, office, industrial, and other income-producing commercial real estate facilities, as well as stabilized, currently income-producing real estate debt (first mortgages, subordinate mortgages and mezzanine capital).

The company concentrates on making investments in long-term, net leased properties in order to minimize ongoing capital expenditures for properties, which are covered by the tenant under the net lease structure and to protect against market cycle volatility. These leases also include rent increases in an effort to further shield the fund from possible inflation.

Additionally, the industrial buildings in the portfolio are well-positioned to profit from the rising need for facilities for e-commerce and logistics. Compared to other real estate product categories, the multifamily portfolio of the fund has strong, risk-adjusted return potential and minimal historical volatility.

The 20% of funds set aside to judiciously purchase and retain securities related to real estate to support the fund's overall investment goals further balances the diversity of CRE assets held by CF Income Trust.

The CF Income Fund has a $2,500 minimum investment requirement for Class D, Class S, or Class T shares. Class I shares demand a larger minimum investment of $1,000,000 per share. If funds are available, the fund anticipates paying distributions to investors each month. Investors looking to invest in a variety of CRE product types, including both debt and equity, will find the CF Income Trust appealing.

Are you prepared to think about investment possibilities that aim to offer higher, more reliable returns on your money? If this is the case, it may be time to think about investing in a high-yield real estate fund. Call us right away. In order to establish which mix of investments would be ideal for you depending on your unique investing objectives, we would be pleased to explore the choices with you.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. Information herein is provided for information purposes only and should not be relied upon to make an investment decision. All investing involves risk of loss of some, or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

1031 Risk Disclosure:

The Importance of a QI in Your 1031 Exchange

A qualified intermediary (QI) is required for all 1031 exchanges. Given the importance of the QI in an exchange, it is imperative for real estate investors to identify one they can trust and rely on. Achieving this, however, can be difficult – how does an investor know whether a particular QI is credible? Here is a brief tutorial on how to select a reputable QI for a 1031 exchange.

What is a QI?

A QI, also known as an accommodator, is an individual or entity that facilitates a 1031, or like-kind, exchange as outlined in Internal Revenue Code (IRC) Section 1031. The role of a QI is defined in the Federal Code as follows:

A qualified intermediary is a person who -

(A) Is not the taxpayer or a disqualified person, and

(B) Enters into a written agreement with the taxpayer (the “exchange agreement”) and, as required by the exchange agreement, acquires the relinquished property from the taxpayer, transfers the relinquished property, acquires the replacement property, and transfers the replacement property to the taxpayer. (26 CFR § 1.1031(k)-1)

An individual does not need to meet any eligibility requirements or acquire a license or certificate to become a QI. However, the Internal Revenue Service (IRS) does stipulate that anyone who is related to the exchanger or has had a financial relationship with the exchanger – such as an employee, an attorney, an accountant, an investment banker or broker, or a real estate agent or broker – within the two years prior to the sale of the relinquished property is disqualified from acting as the exchanger’s QI.

Why is having a QI important in a 1031 Exchange?

Every 1031 exchanger must identify a QI and enter into a written contract prior to closing on the relinquished property. Once selected, the QI has three primary responsibilities: prepare exchange documents, exchange the properties, and hold and release the exchange funds.

Preparing Exchange Documents

Throughout the exchange, the QI prepares and maintains all relevant documentation, including escrow instructions for all parties involved in the transaction.


Exchanging Properties

A 1031 exchange requires the QI to acquire the relinquished property from the exchanger, transfer the relinquished property to the buyer, acquire the replacement property from the seller, and transfer the replacement property to the exchanger. Although the QI also transfers the title, the QI does not actually have to be part of the title chain. 

Holding and Releasing Exchange Funds

For an exchanger to defer capital gains, all proceeds from the sale of the relinquished property must be held with the QI; any proceeds held by the exchanger are taxable. Therefore, the QI must take control of the proceeds from the sale of the relinquished property and place them in a separate account, where they are held until the purchase of the replacement property.

Exchangers must meet two key deadlines for the exchange to be valid. The first comes at the end of the identification period. Within 45 calendar days of the transfer of the relinquished property, the exchanger must identify the replacement property to be acquired. The second comes at the end of the exchange period. The exchanger must receive the replacement property within 180 calendar days of the transfer of the relinquished property. These deadlines are strict and cannot be extended even if the 45th or 180th day falls on a Saturday, Sunday, or legal holiday.

What should investors consider when choosing a QI?

Since a QI is not required to have a license, investors should conduct due diligence to ensure they select an individual who can properly manage the 1031 exchange. Unfortunately, the IRS does not excuse any errors committed by a QI, and, as a result, investors may be required to pay taxes on the exchange due to these mistakes. Here are a few things investors should consider when selecting a QI.

State Regulations

While the federal government does not regulate QIs, some states have enacted legislation that does. For example, California, Colorado, Connecticut, Idaho, Maine, Nevada, Oregon, Virginia, and Washington have all passed laws overseeing the industry. Many of these states have requirements for licensing and registration, separate escrow accounts, fidelity or surety bond amounts, and error-and-omission insurance policy amounts.

Federation of Exchange Accommodators

The Federation of Exchange Accommodators (FEA) is a national trade association that represents professionals who conduct like-kind exchanges under IRC Section1031. The FEA’s mission is to support, preserve, and advance 1031 exchanges and the QI industry. Association members are required to abide by the FEA’s Code of Ethics and Conduct.

In addition, the FEA offers a program that confers the designation of Certified Exchange Specialist® (CES) upon individuals who meet specific work-experience criteria and pass an examination on 1031 exchange laws and procedures. Holders of this certificate must pass the CES exam and meet continuing education requirements. The “designation demonstrates to taxpayers considering a 1031 exchange that the professional they have chosen possesses a certain level of experience and knowledge.”

Knowledge and Experience

As mentioned, a QI’s mistake in a 1031 exchange can result in a taxable transaction. Investors who are in the process of selecting an accommodator should review each individual’s qualifications – including knowledge and experience in the industry – before making a final decision. Investors should inquire whether the individual is full- or part-time; how many transactions and how much in value the individual has facilitated. Additionally, it is important to know whether the individual has any failed transactions and, if so, why.

Knowledge about 1031 exchanges is critical. Not only should potential QIs know the basics, but they should understand the ins and outs of the 1031 exchange process. For example, QIs should know what qualifies as a like-kind property. Likewise, they should know about Delaware Statutory Trusts (DSTs), one of the most commonly overlooked alternative 1031 exchange solutions. Unfortunately, many QIs are not familiar with DSTs. Finding a knowledgeable and experienced QI is crucial for investors who want to successfully defer capital gains while continuing to meet their overall financial objectives.


How should an investor go about selecting a QI?

To find a QI in good standing, investors should seek referrals. Word of mouth can be a great way to find a credible QI. Investors can ask for a referral from a certified public accountant (CPA) with 1031 exchange experience, a real estate attorney, a reputable title company, or even the other party in the exchange.

When vetting a potential QI, investors need to ask questions that will reveal the individual’s depth of knowledge and experience – beyond just the basics. For instance, the FAE requires potential QIs to work full-time for at least three years before they can even sit for the CES exam. Three years is a good baseline to start from when judging a QI’s experience; five to 10 years is a solid amount.

Finding a QI is one of the most critical parts of a 1031 exchange, as the transaction cannot be completed without one. Investors must ensure that their QI is experienced and thoroughly understands the various tax codes involved. Investors also need to ensure that the QI has not been financially connected to them within the past two years and is not a relative, employee, or agent. The IRS does not take these factors lightly; failure to comply with what is presented here may lead to hefty penalty fees – or the IRS may prohibit the exchange from occurring altogether.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. Information herein is provided for information purposes only, and should not be relied upon to make an investment decision. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

1031 Risk Disclosure: