Understanding the Real Estate Investor’s Dilemmas Asset Strategy

In this article series, we previously examined the 1031 exchange, or “like-kind” exchange, as a legal tool to help defer a capital gains tax bill on the sale of a qualified property when reinvesting the proceeds back into another qualified property. We also covered Delaware Statutory Trusts (DSTs) as a real estate investment strategy that provides access to the benefits of direct real estate while offering passive ownership, including the potential for passive income. These two options alone can potentially provide advantageous benefits.

Let’s jump into what the dilemmas of the average real estate investor are, then how these tools work in sequence with each other, and why they can be such a valuable solution for the average real estate investor.

The Dilemmas of the Average Real Estate Investor

There are many types of real estate investors. Some come in the form of large investment groups or high-net-worth individuals with hundred-million-dollar budgets for massive developments for a wide array of property types. However, many real estate investors don’t fit that profile. In fact, the common real estate investor is a middle-class American who may own a two-family property, live in one unit, and rent out the other to help cover their mortgage.

If this type of real estate investor sounds like you, then you’re all too familiar with the risks and issues that arise from managing tenants on a budget and without the capacity of a large real estate investment organization. Property and tenant management can be a costly headache, especially when it comes time to raise rents just to maintain the property and stay up-to-date on legal requirements. While owning an investment property can sound like the key to success, it sometimes comes at a great cost, depending on factors that are unknown at the time of purchasing the property.

The True Cost of These Dilemmas

These costs can be so great—whether on your time, wallet, or well-being—that you’re considering selling your investment property altogether. But even that comes with a new set of costs and decisions! There are potential taxes to pay, closing costs, finding a buyer, and more. For these reasons, you may feel entirely stuck in your position, with costs all around you and no way out.

For a real estate investor plagued with these dilemmas, there are also other tax deferral strategies that may help alleviate these problems and are not limited to those listed below.

Additional Tax Deferral Strategies

Net Lease:

  • Seeks long-term, potential income with the possibility of capital appreciation of the underlying property is among the perks for investors. Investors can invest in high-quality real estate without worrying about management issues like vacancies, renovation costs, or lease fees. When the underlying properties are sold, investors can use a 1031 tax-deferred exchange to invest in another triple-net-lease transaction to defer taxes.
  • Interest Deductions: Interest on loans used to acquire or improve the property can be deductible.

Qualified Opportunity Zones (QOZ):

  • Potential tax benefits associated with the QOZ Program fall into two main categories:
    • Deferral: If a taxpayer invests the capital gain from the sale of any property into a QOF within 180 days of recognizing the gain, taxes on such proceeds may be deferred until the earlier of December 31, 2026, or the disposition of the QOF interest.
    • Elimination: Investors who hold their investment for at least ten years receive a step-up in basis, which means they may be able to pay no tax on the appreciation of their QOF Investment upon disposition of such QOF Investment, regardless of the size of the potential profit. In addition, the step-up in basis eliminates any depreciation recapture tax that would otherwise be owed upon sale.
    • All investments involve risk, and the realization of the benefits is dependent on proper structuring and the structure and performance of the future investments selected. Not all investments will provide all these benefits.

 UPREITs (Umbrella Partnership Real Estate Investment Trusts):

  • Tax-Deferred Exchange: Property owners can exchange their property for operating partnership (OP) units in the UPREIT without triggering a taxable event.
  • Conversion to REIT Shares: OP units can often be converted into REIT shares, which are considered liquid assets. However, this conversion is a taxable event. This allows an investor to liquidate over time as opposed to all at once.
  • REIT Dividends: Real estate investment trusts (REITs) are a popular method for investors to own real estate that generates income without having to purchase or manage property. Investors favor REITs due to their potentially substantial income sources. The trust must distribute at least 90% of its taxable income to shareholders in order to qualify as a REIT. Consequently, REITs typically do not pay corporate income taxes because their earnings are distributed as dividends.

 


Because investor situations and objectives vary this information is not intended to indicate suitability for any individual investor. This is for informational purposes only, does not constitute individual investment advice, and should not be relied upon as tax or legal advice. Please consult the appropriate professional regarding your individual circumstance.

Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated.

Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.

There are material risks associated with investing in private placements, Delaware Statutory Trusts (“DSTs”) and real estate securities including the potential loss of the entire investment principal, illiquidity, tenant vacancies impacting income and revenue, general and real estate market conditions, lack of operating history, interest rate risks, competition, including the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and investors should read the PPM carefully before investing paying special attention to the risk section.

Certain Qualified Opportunity Zone (QOZ) areas may not be able to appreciate as predictably as more established areas. Some neighborhoods may be more accommodating to development than others, impacting the success of the investment. Development and redevelopment of real estate traditionally have more risk than other types of real estate strategies. The availability and cost of construction and development financing is uncertain and represents a risk inherent in the execution of a QOF strategy. The rules and regulations of the QOZ Program are complex, compliance with the QOZ Program comes with significant challenges. QOFs tend to be illiquid investments for ten or more years. Any discussion regarding “Qualified Opportunity Zones” – including the viability of recycling proceeds from a sale or buyout – is based on advice received regarding the interpretation of provisions of the Tax Cut and Jobs Act of 2017 (the “Jobs Act”) and relevant guidance’s, including, among other things, two sets of proposed regulations and the final regulations issued by the IRS and Treasury Department in December of 2019. A number of unanswered questions still exist, and various uncertainties remain as to the interpretation of the Jobs Act and the rules related to Opportunity Zones investments. We cannot predict what impact, if any.

DST 1031 properties are only available to accredited investors (typically defined as having a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last two years; or have an active Series 7, Series 82, or Series 65. Individuals holding a Series 66 do not fall under this definition). If you are unsure if you are an accredited investor and/or an accredited entity, please verify with your CPA and Attorney.

An UPREIT (umbrella partnership real estate investment trust) is a REIT structure that allows property owners to exchange their property and defer taxes on the sale of property in exchange for UPREIT units though capital gains taxes on UPREIT units are subject to standard REIT taxation. UPREITs are generally subject to Internal Revenue Code (IRC) Section 721 exchanges.

A REIT is a security that sells like a stock on the major exchanges and invests in real estate directly, either through properties or mortgages. REITs receive special tax considerations and typically offer investors high yields, as well as a highly liquid method of investing in real estate.  There are risks associated with these types of investments and include but are not limited to the following:  Typically, no secondary market exists for the security listed above.  Potential difficulty discerning between routine interest payments and principal repayment.  Redemption price of a REIT may be worth more or less than the original price paid.  Value of the shares in the trust will fluctuate with the portfolio of underlying real estate.  Involves risks such as refinancing in the real estate industry, interest rates, availability of mortgage funds, operating expenses, cost of insurance, lease terminations, potential economic and regulatory changes.  This is neither an offer to sell nor a solicitation or an offer to buy the securities described herein.  The offering is made only by the Prospectus.

DST 1031 properties are only available to accredited investors (typically defined as having a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last two years; or have an active Series 7, Series 82, or Series 65.  Individuals holding a Series 66 do not fall under this definition).  If you are unsure if you are an accredited investor and/or an accredited entity, please verify with your CPA and Attorney.

Advisory Services are offered through Asset Strategy Advisors, LLC (ASA), a SEC Registered Investment Advisor. Securities offered through registered representatives of Concorde Investment Services, LLC. (CIS), member of FINRA/SIPC. Insurance Services offered through Asset Strategy Financial Group, Inc. (ASFG). ASA, CIS, and ASFG are independent of each other.

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