Backstory: I'm in the process of selling a property that has had a significant amount of appreciation. It was purchased as a primary residence and I "house hacked" it for several years before relocating with work and it has remained as a full rental unit ever since. However, due to the fact that there is no cash flow from the property and a significant amount of equity tied up (should net ~$250-300k), resulting primarily from the appreciation and essentially earning no return on that "new" money...along with the archaic laws/rules Seattle has/is enacting that will remain long after COVID ends, I decided to sell. Fortunately the tenant was amenable to this (in Seattle you can not force them to leave, even to sell...even if their lease ends - not sure how that's even legal but that's a whole different post) and actually decided to leave earlier than their lease date. Unfortunately, I haven't lived there for 2 of the past 5 years so my best option is to defer tax payment via 1031 as far as I can tell (if anyone else has a different take, I'm all ears). Also note, I did look into rate and term as well as a cash out refi to put some of the equity to use and/or enable the unit to cash flow and reduce the interest rate but ultimately the current state of Seattle, their rent freezes and anti-small landlord doctrines forced my hand.
Question (finally...I apologize): Is it possible to 1031 gains from a sold property into an interest in a syndication if you're a passive investor and not the sponsor? Also, as a passive investor, can anyone give me the broad strokes of any tax benefits they may also be entitled to similar to a solely owned piece of real estate or are those deductions pretty much off the table? I'm looking to find a good investment for the gains I should make but the $ amount is larger than I'm used to handling, my time is limited as I have a full time day job (that I enjoy and am not ready to part with), and I'm not opposed to purchasing another property (I have 3 SFR out in OKC) - preferably a larger Multi family or small apartment complex at this point. But due to time constraints and needing to role the funds from the future sale of the Seattle property relatively quickly, I thought syndication may be a good avenue. Any input would be greatly appreciated and again I apologize for the long winded "story" to preface my situation. Thank you in advance.
This seems like a question for a cpa, or a lawyer, or both. 😂
Though from my understanding of it, I really doubt that a share in syndicated property will meet the IRS "like-kind" policy for the 1031. I hope I'm wrong!
Have you explored possibility of holding the property in a discretionary trust? Again, not a lawyer or accountant, but there's definitely some favorable tax options with certain types of trusts iirc. Might be worth checking out. 👽
@Zackary Waage You are correct that this is a question your CPA. I have had this question come up several times and the way that my CPA has explained the IRS "like-kind" boils down to the title of the purchase. As you are going to be able to sell your home in the name of @Garrett Smith but you are buying a share of syndication titled XYZ syndication, so the IRS looks at the fact that the titles do not match so that would disqualify it per the IRS. But again, this is just what my CPA said and you should check with your own CPA on this topic.
@Garrett Smith you can use syndication for a 1031 exchange, but it needs to be structured differently than most deals in the marketplace. Most deals are structured to make passive investors limited partners. That won't work for 1031 exchange. So you need a tenant in common (TIC) structure.
This is possible, but it’s harder to convince a syndicator to build a deal that way.
Another option is Delaware Statutory Trust (DST). Basically DST is large scale syndications built for 1031 exchanges.
Of course you can always buy direct and get a 3rd party manager. But it sounds like that would be time consuming trying to deal with your sale at the same time.
@Brandon Bruckman is spot on with the two methods (DST and TIC). We will structure around an investors 1031 considerations depending on check size relative to deal size.
@Garrett Smith let me elaborate on @Brandon Bruckman 's good points above. There are syndicated deal sponsors that specialize in 1031-exchange-friendly deals (either exclusively or as a side product) and that might be worth investigating for you. I have a contacts in this space if you're interested.
Given your circumstances I think that a 1031 exchange is likely the most tax-efficient option for you. Again, Brandon is right to highlight DSTs as a cousin of syndicated investments for a passive investor.
I have a question relating to this thread.
If Garrett received this property through inheritance, wouldn't he benefit from the "stepped-up value" and only owe taxes on the amount of the sale over and above the fair market value? Could that be zero tax if he sells at or below fair market value? Then he has the cash without any tax penalty and can invest some or all of it later without being bound to the pressure and process of 1031?
Maybe this benefit is only possible in some states (I'm in Texas). Thus, the recommendation to seek CPA guidance is spot on.
Good luck, Garrett.
@Patricia Hinojos yes, an asset received through inheritance receives a step up in tax basis equal to the FMV at time it is bequeathed. The inheriting party may indeed dispose of the asset at that time without need of a 1031 exchange.
I've read Garrett's post a few times and don't believe that fact pattern fits. Perhaps I am missing something and need stronger coffee?
Hi @Garrett Smith ,
The majority of syndications are structured as some type of partnerships (GP, LP or LLC), which means what you are really buying is a partnership interest and not an interest in real estate so it would not qualify for 1031 Exchange treatment. You need to actually buy something that is classified as a direct interest in real property.
@Brandon Bruckman is right on the money. Syndications that are structured as tenant-in-common interests (TICs) or Delaware Statutory Trusts (DSTs) would qualify for 1031 Exchange treatment. I would reach out to Brandon if you are looking for more information on DSTs.
Hi @Patricia Hinojos ,
Yes, heirs that inherit property generally receive a step-up in cost basis (but not always). If they received a step-up in cost basis, they would likely be able to sell the property and not incur any taxes unless it has increased in value since they inherited the property.
It is important that you meet with your CPA to make sure that you hold title properly so that you will qualify for a step-up in cost basis upon your death. This helps protect your heirs from missing the step-up in cost basis under certain circumstances.
Garrett Smith as a CPA, I have assisted several clients with 1031 exchanges. I agree with Brandon Bruckman that a DST may be a good option for you. One client of mine completed an exchange of 2 properties in CA for a new California property as well as an interest in 2 DST's with properties in 2 different states. Each of the properties acquired is now treated as a rental property on my client's tax returns...resulting in all of the normal write-offs for those properties. I would suggest bringing your CPA in early on this transaction to head off any issues down the road.
@Garrett Smith , finding syndications that will qualify (letting you purchase a TIC interest in the asset) will prove difficult. However, one step down the passive ladder from that would be the opportunity to move into fully owned NNN commercial. Most of the passivity of a DST (especially with corporate guaranteed NNNs). And still qualifying for 1031 treatment. Depending on the sector you choose the market is not as frantic so you'll find a. little more relaxed pace for purchase.
And the returns are generally better than DSTs and less than the promised returns of syndications. Depending on your exit price that might be a whole new world to open up for you.
Greatly appreciate all the input from the community. Thank you all very much. Unfortunately I didn't inherit the property but that is a good question @Patricia Hinojos . @Brandon Bruckman very much appreciate the info and am looking at the buy direct option as well. I have a few other properties in the OKC market and a PM out there but it is time consuming to find the right deal (trying to start now before the sale - reaching out in as many potential ways as possible). I have spoken with my CPA a bit about this situation and she is pretty knowledgeable but due to tax season and the fact that she isn't able or willing to directly handle the 1031 I wanted to reach out to a few others for input. I appreciate it all and will not infer any of it as legal advice. I am interested in the Delaware Trust info and if possible reach out to a few of you directly for additional input, asset protection is on my list of to-do's as it is. I'd heard of DST's before but wasn't aware of their 1031 benefits. @Dave Foster I'm not familiar with NNN's but will reach out to you to discuss more if you're available. I've definitely been on a journey in discovering more of the nuances with real estate and continue to do so (makes for long days at work and long nights trying to learn more and build my real estate investments but hopefully worth all the effort - and honestly it is pretty fun). Can't thank you all enough for the support, if there is ever anything I can do in return or provide business to you directly, don't be afraid to reach out. My hope is that my business in the community continues to grow.