1031 Exchange into a Fund Like the Ones on Fundrise

12 Replies

@Brian M., It's highly doubtful. In order to be eligible for 1031 treatment you must take deeded title to investment real estate. Many of the "crowd funding" platforms give you membership interest or ownership in entities that own real estate and not deeded interests in the actual real estate.

If you get a deed you're buying real estate and that qualifies for 1031. If not then probably not.

@Brian M., our pal, @Dave Foster is (as always) correct. Generally speaking, the only 2 legal entities that allow multiple investors to pool 1031 exchange proceeds are the Tenant-in-Common (TIC) and Delaware Statutory Trust (DST). The closest thing to a "fund" with 1031 exchange proceeds would be for an investor to make several smaller investments in DSTs, perhaps even focusing on DSTs which own multiple properties - in a way, creating your own "fund". Of course, this will still somewhat be limited by the amount of exchange proceeds available and may result in needing to manage several exchange "rollovers" in the future. TICs and DSTs work for a lot of investors, but they (like any investment) are certainly not a "one size fits all".

It's still early, but Fundrise is in the process of creating an opportunity zone fund which can provide some capital gains tax shelter. I know very little about this and it appears legislation has not yet been finalized. I am definitely interested in this topic since I do plan to sell some of my LA properties later this year.

Whoa there folks!

There is a huge difference between a property that qualifies for 1031 treatment and an opportunity zone fund.  It appears that there are some ways using opportunity zones to take recognized gains and create a tax deferred framework.  I'm not the be all end all to speak to that so maybe @David Sillaman and @Tony Kim can shed more light on that from the opportunity zone fund perspective.  But my impression like Tony's is that the true breadth and depth of the OP Zone legislation isn't all ironed out yet.

In any event though - No it is not normal for you to be able to 1031 into a real estate fund @Brian M. In order to be eligible for 1031 you must be able to take a deeded interest in actual real estate to replace the actual real estate you sold. Specific to your question No you cannot 1031 into Fundrise (unless theres a section for you to take TIC deeded title to a Fundrise property that I missed in looking at their offerings. They're a mutual fund for real estate. That does not qualify for 1031.

And an opportunity zone fund does not qualify for 1031 unless you are taking deeded interest in real estate in an opportunity zone.  What I'm dying to learn is the true nature of how an opportunity zone could work if I don't do a 1031.  that's the question to be addressed - opportunity zones as an alternative for 1031s?

Lets talk 1031's. 

The biggest differences.

1) With a rollover into Opportunity Fund you don't have to roll the principle in unlike that of a 1031. With 1031 you to roll both the principle and gain into a like kind exchange. 

2) The capital gains from the 1031 are tax deferred so long as you continue to keep rolling into another 1031. 1400z(2)(a)-1 Gains rolled into opportunity funds are counted as an offset to your AGI, based on the amount invested in the opportunity fund. You only have to invest the gain up to the amount you want to lower your AGI by. So unlike a 1031 you can still keep out principle and even a portion of the gain and claim all the benefits associated with the Opportunity Fund. 

3) Unlike 1031 Opportunity Funds don't have intermediaries or fees. 

4) Both have a 180 day rule. Unlike 1031's there is no need for the 45 day Identification Period. 

5) Unlike 1031's you don't have the rules of like-kind exchanges. 

6) With 1031's at some point a piper has to be paid. With Opportunity Funds as long as the investment is held for 10 years you get a step up in basis to the FMV at the time and the gains themselves on the fund itself if tax free.

5) You can cash out early at the 5 year mark and begin to see the initial 10% step up in basis. Another 5% added at the 7 year mark. 

Even though Opportunity Funds are new their is more than enough guidance initially. Especially for Opportunity Funds that issue zone stock vs zone partnership. Updated letters were sent to congress a bit over a week ago asking for more clarification on the zone partnerships and zone business property. If you have a gain realized you only have 180 days to decide or miss out on the tax deferment. Opportunity Zone Stock would fall under SEC guidance which there is plenty of in SEC 506 Reg D. In addition as an early investor into funds zone stock would give you the added benefit of the investment itself being tied to the whole fund and not a individual property the fund invests in. Spreading the risk out over multiple investments. 

But if you have 1031 and sold the property and are thinking about either rolling into another 1031 or looking at Opportunity Funds. Opportunity Funds will end up being the biggest winner.

@Brian M. Yes you can roll gains from a 1031 rental in to opportunity funds. Opportunity Funds are open for investments from any type of unrealized capital gain. Primary, Rental, Stocks, Crypto doesn't matter. Any type of capital gains tax can deferred and rolled into the Opportunity Funds.

Originally posted by @David Sillaman :

Lets talk 1031's. 

The biggest differences.

1) With a rollover into Opportunity Fund you don't have to roll the principle in unlike that of a 1031. With 1031 you to roll both the principle and gain into a like kind exchange. 

2) The capital gains from the 1031 are tax deferred so long as you continue to keep rolling into another 1031. 1400z(2)(a)-1 Gains rolled into opportunity funds are counted as an offset to your AGI, based on the amount invested in the opportunity fund. You only have to invest the gain up to the amount you want to lower your AGI by. So unlike a 1031 you can still keep out principle and even a portion of the gain and claim all the benefits associated with the Opportunity Fund. 

3) Unlike 1031 Opportunity Funds don't have intermediaries or fees. 

4) Both have a 180 day rule. Unlike 1031's there is no need for the 45 day Identification Period. 

5) Unlike 1031's you don't have the rules of like-kind exchanges. 

6) With 1031's at some point a piper has to be paid. With Opportunity Funds as long as the investment is held for 10 years you get a step up in basis to the FMV at the time and the gains themselves on the fund itself if tax free.

5) You can cash out early at the 5 year mark and begin to see the initial 10% step up in basis. Another 5% added at the 7 year mark. 

Even though Opportunity Funds are new their is more than enough guidance initially. Especially for Opportunity Funds that issue zone stock vs zone partnership. Updated letters were sent to congress a bit over a week ago asking for more clarification on the zone partnerships and zone business property. If you have a gain realized you only have 180 days to decide or miss out on the tax deferment. Opportunity Zone Stock would fall under SEC guidance which there is plenty of in SEC 506 Reg D. In addition as an early investor into funds zone stock would give you the added benefit of the investment itself being tied to the whole fund and not a individual property the fund invests in. Spreading the risk out over multiple investments. 

 What about recapture? In 1031 you have no recapture, but it seems like opportunity fund you would have the recapture.

The Opportunity Funds are based on the capital gains owed to uncle same. 

WIth 1031's you may be required to "recapture" the depreciation deducted by you on your real estate investment property upon the disposition (sale) of the investment property. This means that you may have to recapture or add back into your taxable income the amount of depreciation taken on your investment property when you dispose of (sell) your investment property.

Depreciation allowed or allowable, whether deducted or not, must be included in the depreciation recapture income tax computation upon the disposition (sale) of your real estate investment.

Recapture could increase your AGI. However, the opportunity funds are designed to offset that without the need to roll into another 1031. Basically Opportunity Funds open up the principle back into the economy instead of keeping it tied up in the property with a 1031. While at the same time circumventing the typical process of injecting capital into distressed areas. By removing the local aspect and the grant aspect of typical funding into those areas, the TCJA is really pushing for more of a capitalistic approach to community revitalization. 

Originally posted by @David Sillaman :

The Opportunity Funds are based on the capital gains owed to uncle same. 

WIth 1031's you may be required to "recapture" the depreciation deducted by you on your real estate investment property upon the disposition (sale) of the investment property. This means that you may have to recapture or add back into your taxable income the amount of depreciation taken on your investment property when you dispose of (sell) your investment property.

Depreciation allowed or allowable, whether deducted or not, must be included in the depreciation recapture income tax computation upon the disposition (sale) of your real estate investment.

Recapture could increase your AGI. However, the opportunity funds are designed to offset that without the need to roll into another 1031. Basically Opportunity Funds open up the principle back into the economy instead of keeping it tied up in the property with a 1031. While at the same time circumventing the typical process of injecting capital into distressed areas. By removing the local aspect and the grant aspect of typical funding into those areas, the TCJA is really pushing for more of a capitalistic approach to community revitalization. 

There's a difference between being able to exclude the capital gain and it being a reduction in your AGI.

26 USC 1400Z-2: Special rules for capital gains invested in opportunity zones

Section 1A seems reads to me that the gain is excluded and is not a reduction of AGI. For example, someone could be at 0% capital gains rate gain deferral doesn't seem to indicate you can offset ordinary income.