Unleashing the Power of Passive Real Estate Investing

The phenomenon is known as the "Amazon Effect", and chances are you've heard about it more than once. This e-commerce behemoth has revolutionized virtually every aspect of our lives, transforming consumer attitudes towards shopping and product accessibility and drastically altering the global supply chain. For institutional investors, the Amazon Effect has significantly boosted the appeal of industrial properties in the commercial real estate market, with properties housing Amazon operations being particularly sought after.

Amazon: A Rapidly Expanding Player in the Commercial Real Estate Scene

Aerial view of Amazon distribution center in Toronto illustrating the potential for investment real estate and the benefits of tax deferral through a 1031 exchange

Amazon is witnessing one of the fastest expansions as a tenant. The company recently unveiled plans to establish 1,000 small delivery hubs near densely populated regions across the US to streamline product delivery to consumers. This rampant growth spurred by e-commerce giants like Amazon has led CBRE to forecast a surge in demand for an additional 1.5 billion square feet of industrial space within the next half-decade. This demand has positioned industrial distribution properties as some of the most coveted assets in the market.

Moreover, Amazon's relentless demand has prompted the company to consider alternative properties. Many market analysts anticipate that Amazon could repurpose defunct and unoccupied large-scale department stores into industrial distribution centers, further indicating the skyrocketing demand for such spaces.

Although investors have their sights set on the expansive e-commerce market, Amazon emerges as arguably the most coveted and creditworthy tenant for these properties. Property owners are eager to secure long-term triple net leases with Amazon, as they effectively mitigate operating costs for the owner. Similar to most industrial properties, Amazon operates facilities on triple net leases, under which they cover the majority of operating expenses, including common area maintenance charges, insurance, and property taxes.

This upward trend isn't exclusive to large institutional investors. Small and medium-sized investors also have the opportunity to strive to capitalize on the earnings potential of Amazon's industrial properties. They can do so through tax-deferred 1031 exchanges and passive real estate investment strategies, broadening their access to this burgeoning sector.

What Does Passive Real Estate Investing Entail?

Various financial investment products in cartons demonstrating diverse options for investment real estate and the power of tax deferral through a 1031 exchange

Passive investing denotes a scenario where an investor takes a non-active role in the management of the property or business. It spans a range of asset types, from equity assets such as stocks or mutual funds, to real estate assets including Real Estate Investment Trusts (REITs) or Delaware Statutory Trusts (DSTs). Within real estate, passive investment can occur directly or indirectly.

Direct Passive Real Estate Investment

While real estate is often seen as a passive income asset, anyone who's managed an apartment complex firsthand knows it can be quite the contrary. However, owners who delegate the day-to-day management, upkeep, and leasing of the property to professional property management firms, or commercial owners with tenants on triple-net leases (where tenants bear most operational costs), can enjoy a far more passive investment experience.

With this strategy, an investor's role is reduced to simply collecting potential income each month, while their involvement in the property's operation remains minimal.

Indirect Passive Real Estate Investment

Indirect passive real estate investing involves a completely hands-off approach. An investor can participate in various real estate equity vehicles, acquiring fractional ownership in an asset or portfolio of assets. Beyond the initial capital investment, the investor plays no part in managing the property but shares in any profits or income generated.

Potential Advantages of Passive Real Estate Investment in Commercial Real Estate

Passive real estate investing in commercial real estate has seen significant growth, and there are now more opportunities than ever to invest your capital in high-quality, hands-off equity vehicles. Commercial real estate not only offers the possibility of a steady income stream and robust appreciation potential, but these assets also typically have a high entry barrier and require substantial expertise for successful business strategy execution.

However, passive investing can unlock the financial and wealth-building potentials of commercial real estate assets, making it an attractive option for many investors.

Three Key Options for Passive Real Estate Investment

Nowadays, there are numerous ways to invest in real estate through equity vehicles. Some methods, such as crowdfunding or opportunity zone funds, are relatively new, while others, like Delaware Statutory Trusts, REITs, and real estate funds, are established and tested vehicles with widespread popularity.

Delaware Statutory Trust (DST)

A Delaware Statutory Trust (DST) is a business trust that owns and manages real estate property. A real estate firm, known as the DST sponsor, initially acquires a property using its own capital, structures the property within a DST, and subsequently introduces it to the market through an official offering.

Investors purchase a fractional or concurrent ownership stake in a high-quality, professionally managed asset and potentially receive monthly income corresponding to their share of ownership. Over the past decade, DSTs have gained popularity due to their eligibility as replacement properties in 1031 exchanges.

Real Estate Investment Trusts (REITs)

A Real Estate Investment Trust, or REIT, is a company that purchases, owns, and operates real estate assets. There are public and private REITs, as well as traded and non-traded REITs. Private non-traded REITs typically engage with institutional capital sources, whereas public traded and non-traded REITs are registered with the SEC.

Shares of these are either traded on public exchange markets or directly purchased from the issuer. Historically, they've provided attractive dividends averaging around 5%, which is considerably higher than the average stock dividend of 2%.

Real Estate Funds

Real estate funds present another option, acting as an alternative to investing directly in a single REIT. These funds, such as real estate interval funds, invest in a variety of REITs, offering investors enhanced diversification. Some real estate funds are traded on public exchange markets, while others can be directly purchased through the fund.

Contrary to DSTs and REITs, real estate funds do not distribute dividends or monthly income. Rather, they seek to generate value through appreciation, realized at the exit or sale of the investment.

Investing in Amazon via a 1031 Exchange DST Property

Thanks to these passive investment strategies, individual investors can tap into high-quality, institutional-grade assets - bringing us back full circle to the Amazon Effect. While these strategies aren't exclusively tied to Amazon, they provide an avenue for investors to attempt to capitalize on the thriving industrial market.

One such strategy worth considering is employing a 1031 Exchange with a Delaware Statutory Trust to own Amazon Net Lease properties as a 1031 replacement property. This approach combines the tax deferral advantages of a 1031 Exchange, the passive management benefits of a DST, and the consistent income potential offered by Amazon's industrial properties.

Understanding the Mechanics of a Delaware Statutory Trust

Since 2004, DST investments have been recognized as suitable replacement properties in a 1031 exchange. Even though this exchange allows owners to transition their business model from direct to fractional ownership, the fundamental principles of a 1031 exchange remain the same. Upon selling an asset, the seller has 45 days to identify a replacement property, in this case, one or more DSTs.

The identified replacement property must comply with one of the three permissible identification methods: the 3-property rule, 200% rule, or 95% rule. The transaction must be completed within 180 days from the original property sale date. Similar to a conventional exchange, investors can defer capital gains taxes through this process.

Numerous reliable DST investments are available from trusted sponsors with a proven track record. DST sponsors undertake the task of structuring the trust, which encompasses property inspection, due diligence, securing debt if required, and organizing the DST offering in accordance with SEC regulations. All these costs are included in the official offering.

When considering properties occupied by Amazon, investors should look out for industrial DST offerings. Due to SEC regulations, DST sponsors are prohibited from publicly advertising certain offerings. To locate an offering that aligns with your objectives, it's advisable to conduct thorough research on reputable sponsors and consult with a licensed 1031 Exchange professional.

Pros & Cons of Delaware Statutory Trusts

Investing in a DST via a tax-deferred 1031 exchange offers the potential for significant benefits. Shifting away from direct ownership alleviates the responsibilities associated with daily property management. Plus, DSTs generally have low minimum investment requirements – typically $100,000 – which allows investors to spread their investment across multiple DST properties and diversify their portfolio.

As DST investments are usually comprised of institutional-grade assets, such as an Amazon net leased property, they potentially provide higher monthly income and appreciation compared to direct ownership – although this largely depends on the specific asset.

However, as with any investment, there are also drawbacks. Two of the risks associated with DSTs relate to liquidity constraints and the timing of exits. DST properties are usually held for a period ranging from 3 to 10 years, and early exits are generally not feasible.

While the hands-off management nature of a DST is one of its attractive features, it also implies that investors do not have a say in management decisions. Therefore, it's critical to select a robust sponsor with a demonstrated successful history when investing in DST real estate.

Leveraged DST properties also present a risk. High leverage – say 80% – can notably decrease monthly cash flow as the majority of profits will be allocated towards servicing the asset's debt. Most DSTs apply leverage between 50% - 58% to avoid undue risk. Consequently, when considering a DST property, thorough due diligence is essential prior to investing.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. 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. Any information provided is for informational purposes only.

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: 

Utilizing a 1031 Exchange for Constructing an Investment Property

Utilizing a 1031 Exchange for Constructing an Investment Property

A 1031 exchange serves as a valuable tool for real estate investors seeking to defer the payment of capital gains taxes when selling an investment property and reinvesting the proceeds. Without utilizing a 1031 exchange, a sale and subsequent purchase would result in capital gains taxes being owed on the difference between the adjusted basis and the sale price.

To illustrate, let's consider an example. Imagine you have owned a piece of land for five years, initially acquiring it for $250,000 along with associated acquisition costs. Over time, you invested $100,000 in improvements, bringing your adjusted basis to $350,000.

If you decide to sell the property for $600,000, you would be liable for capital gains taxes on the $250,000 difference. Depending on your tax bracket, this could amount to $50,000 if you are in the highest bracket.

Let's consider an alternative scenario where you opt for a 1031 exchange, adhering to the procedures and timelines set forth by the IRS, to reinvest the proceeds from the sale into a new property. This strategic approach enables you to invest the entire $600,000 rather than just $550,000, creating a significant financial advantage. Key requirements for a successful 1031 exchange include:

  1. Engaging a Qualified Intermediary (QI): It is essential to work with a Qualified Intermediary who will facilitate the entire process. The QI establishes an account to hold and manage the sale proceeds between the initial property sale and the final acquisition.
  1. Timelines and Identification: Within 45 days of the sale, you must identify potential replacement properties that meet the criteria outlined by the IRS. Subsequently, you must complete the purchases (or purchases) within 180 days from the initial sale date, ensuring strict compliance with the prescribed timelines.
  1. Value and Debt Matching: To meet the requirements of a 1031 exchange, the value and debt levels of the new investment property should be equal to or greater than those of the relinquished property. This balance helps maintain the integrity of the exchange process.

While a 1031 exchange for investment property construction entails a complex transaction and tight timelines, the tax deferral can provide an opportunity for increased leverage in the reinvestment process. Additionally, utilizing this tool for subsequent investments can lead to a transfer upon your passing, whereby the heir receives the property at its stepped-up value, ultimately eliminating any deferred taxes.

Exploring Building Opportunities within a 1031 Exchange

Couple exploring building opportunities within a 1031 exchange for their new construction investment property

If you have aspirations to build on the replacement property acquired through a 1031 exchange, there are avenues to pursue. The approach depends on the initial value and condition of the replacement property:

  1. Equivalent Value: If the replacement property, in its current state, is already of equal value to the relinquished asset, you have the freedom to proceed with the exchange and embark on your desired construction project.
  1. Value Enhancement: However, if the designated replacement property requires improvements to match the value of the relinquished asset, certain conditions must be met. The required work must be completed within the 180-day timeframe allocated for the exchange. Additionally, as part of the identification process within the initial 45 days, the investor must outline the planned improvements for the replacement property.

In conclusion, while it is possible to transact a 1031 exchange into new construction, there are important considerations to keep in mind. The replacement property must meet the requirement of being equal to or greater in value than the relinquished asset. If you plan to sell a retail property and embark on constructing a multifamily housing structure on vacant land, there are additional complexities involved.

If the value of the new asset already matches that of the original property, the process is straightforward. However, if the new acquisition initially holds a lower value due to ongoing construction, it must be completed within the 180-day exchange period. Throughout this period, the title should be held by a qualified intermediary.

To successfully navigate a 1031 exchange into new construction, it is vital for investors to diligently follow the rules and timelines set forth by the IRS. Engaging the services of a skilled intermediary can provide invaluable assistance in ensuring compliance and facilitating a smooth transaction. By carefully adhering to the guidelines and working with experienced professionals, investors can leverage the benefits of a 1031 exchange while pursuing their new construction projects.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. 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. Any information provided is for informational purposes only.

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: 

Using 1031 Exchange Funds for Earnest Money: Is it Allowed?

A 1031 exchange allows real estate investors to delay paying capital gains taxes by replacing their sold properties with similar replacement assets. One rule is that sellers cannot handle funds directly and must use a qualified intermediary for monetary transactions. This leads to the question of how earnest money is handled in 1031 exchanges. Let's explore earnest money treatment in both selling relinquished assets and purchasing replacement properties.

Now, let's delve into the treatment of earnest money in 1031 exchanges. Earnest money is a deposit made by the buyer to demonstrate their serious intent to purchase a property. In traditional real estate transactions, earnest money is typically held by a title company, commercial brokerage, or even the seller.

In a typical real estate transaction, buyers often provide earnest money deposits as a demonstration of good faith and their commitment to securing the necessary funds for the property purchase. This earnest money is typically required once both parties have entered into a legally binding purchase agreement.

However, when it comes to a 1031 exchange, the treatment of earnest money for relinquished assets differs from standard transactions. In a 1031 exchange, the earnest money placed as a deposit on the relinquished assets should always be held by a third party. This third party can be a qualified intermediary, an attorney, a broker, or any other agent designated to handle the exchange process.

The reason for this requirement is that individuals engaging in a 1031 exchange are prohibited from taking receipt of any funds at any point during the exchange process, according to the regulations set forth by the Internal Revenue Service (IRS).

When the time comes to close the deal, the earnest money deposit can be transferred to the closing agent. The closing agent then delivers these funds to the designated exchange facilitator, who utilizes them to complete the sale of the relinquished asset.

Although this may seem like a circuitous route for handling earnest money deposits, it is a necessary precaution to ensure compliance with the rules and regulations of the 1031 exchange. By following this approach, exchangers can rest assured that they are adhering to the IRS guidelines and not directly handling any funds during the sale of their relinquished assets.

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Earnest Money and Replacement Assets

In a 1031 exchange, exchangers are responsible for placing earnest money deposits to secure their replacement properties once they enter into purchase agreements. There are two options for handling these earnest money deposits:

  1. Direct Payment to Seller: Exchangers have the choice to pay the earnest money directly to the seller. This option does not create any tax or regulatory complications. If there is enough capital from the relinquished asset, the exchanger can even have these funds returned at the closing of the transaction.
  2. Qualified Intermediary Involvement: Exchangers who prefer to utilize funds from their relinquished assets can have their qualified intermediary (QI) place the earnest money deposits on the replacement properties. To do this, the purchase agreement must be assigned to the QI. It is important to specify that any refundable earnest money will be returned to the exchange facilitator if the deal falls through, ensuring that the exchanger never directly handles any funds.

In Conclusion

A fundamental rule in 1031 exchanges is that exchangers must avoid handling any funds from the sale or purchase of properties involved in the exchange process. This rule, known as constructive receipt of funds, is crucial to maintaining the tax-deferred status of the exchange.

If an exchanger were to directly receive and retain earnest money deposited on a relinquished asset throughout the closing process, it would result in a taxable event due to the generation of boot (non-like-kind property or cash). To ensure compliance and minimize tax consequences, it is always recommended to assign the earnest money to a third party.

On the other hand, exchangers have the option to utilize the proceeds from their relinquished assets as earnest money deposits on replacement assets, as long as the purchase agreement has been assigned to their qualified intermediary. By following the appropriate documentation and planning procedures, earnest money can be handled within 1031 exchange transactions without triggering any tax implications.

Proper adherence to the rules and regulations surrounding the treatment of earnest money is essential to successfully execute a 1031 exchange while deferring capital gains taxes.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. 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. Any information provided is for informational purposes only.

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:

·     There’s no guarantee any strategy will be successful or achieve investment objectives;

·     All real estate investments have the potential to lose value during the life of the investments;

·     The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities;

·     All financed real estate investments have potential for foreclosure;

·     These 1031 exchanges are offered through private placement offerings and are illiquid securities. There is no secondary market for these investments.

·     If a property unexpectedly loses tenants or sustains substantial damage, there is potential for suspension of cash flow distributions;

·     Costs associated with the transaction may impact investors’ returns and may outweigh the tax benefits

How to Handle DSTs For Tax Purposes

As a first-time investor in a Delaware Statutory Trust (DST), tax season can be an overwhelming and confusing time. In addition to your regular tax documents, you will need to be aware of what to expect from your DST's tax reporting. This article aims to provide you with information to help you prepare for the year-end tax season and understand the tax documents related to your DST investment.

The Impact of Entity Type on Tax Filing Requirements for DST Investors

As an investor in a Delaware Statutory Trust (DST), the type of entity in which you hold your beneficial interests can affect how and when you need to file your taxes. The deadline for your tax filing can differ depending on whether you are filing as a corporation or an individual/pass-through entity, and this is unrelated to your DST investment.

If you invest in a DST through an S-Corp or partnership, your tax filing deadline is March 15th, which is earlier than the standard April 15th deadline. On the other hand, if you invest in your name individually or via a pass-through entity like an LLC, the corporation deadlines do not apply to you. Your tax filing deadline is the individual tax return filing deadline of April 15th. This also applies if you are filing as an estate, trust, or C-Corp.

States and DSTs

Delaware Statutory Trusts (DSTs) may own one or more income-generating properties across multiple states, which can make tax filings complicated for investors. Filing requirements may differ based on the state in which the properties are located. States like Texas or Florida, for example, do not have a state income tax, while other states have de minimis filing standards that determine whether an investor needs to file in that state based on the amount of income earned.

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Investing in a DST that owns properties in multiple states means that investors will need to file in each state that has an income tax. This can increase the cost of tax filings due to the need to file in multiple states, as well as the need to hire tax professionals to assist with the filing process. Each state has its own rules and regulations regarding tax filings, so it's important to consult with a tax professional to ensure compliance.

Despite the additional costs, DST tax filings are generally considered to be more straightforward and simple than tax filings for direct property ownership. This is especially true for properties with various types of personal property on them that have different depreciation schedules. When investing in a DST, it's important to consider the potential impact on tax filings and to plan accordingly to ensure compliance with state regulations.

Documents for Tax Filing

If you’re a first-time investor in a Delaware Statutory Trust (DST), tax season can be a confusing time. Unlike other investment types, DSTs don’t typically send out K-1s or 1099s. Instead, you’ll receive separate year-end statements for every DST you’re invested in.

Additionally, there isn’t a consistent statement used by all sponsors. Some sponsors may provide a grantor letter, while others may provide a modified 1099. In general, a pro-rata operating statement is sent out, which includes income and expenses for each property. This statement is sometimes referred to as a substitute 1099.

It’s essential to give any DST documents you receive to your tax professional to complete your tax return. If you don’t have a tax professional, some DST sponsors may provide a directory of CPAs that you can work with.

It’s also important to be aware that investing in a DST that owns income-generating properties in multiple states can complicate your tax filings. You may be required to file in every state that has an income tax, which can increase costs due to filing in multiple states. However, DST tax filings are typically more straightforward and simple than tax filings for direct property, especially if that direct property has any personal property on it with various depreciation schedules.

In summary, as a DST investor, you can expect to receive separate year-end statements for every DST you’re invested in. These statements will provide information on income and expenses for each property. Be sure to give any DST documents to your tax professional to complete your tax return, and be aware of any state tax filing requirements for your DST investments.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. 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. Any information provided is for informational purposes only.

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:

What is a "Mortgage Boot" in the Context of a 1031 Exchange?

A 1031 Exchange is a powerful investment strategy that enables you to defer capital gains taxes and retain your wealth when selling investment properties. This strategy is made possible through the concept of like-kind exchanges, which allow you to reinvest the gains from the sale of your property or asset into another similar one. By doing so, you can defer your capital gains tax liability, freeing up more money for future investments.

This investment strategy is an attractive option for many investors, as it provides an opportunity to defer taxes and strive to accumulate more wealth over time.

Whether you're an experienced investor or new to the world of real estate, a 1031 Exchange can provide a tax-efficient way to grow your wealth. Consider seeking the advice of a financial planner or accountant to help you navigate this investment strategy and make the most of your capital gains.

However, if you don't fully reinvest the proceeds, it can result in an "exchange boot," triggering capital gains taxes. To avoid this, it is important to understand the concept of exchange boots in 1031 Exchanges and how to properly execute the property swap so that you don't incur capital gains taxes.

So what is an Exchange Boot?

A key aspect of a 1031 Exchange is the requirement to reinvest all profits made from the sale of a property into another similar asset in order to fully defer the taxes owed. Any funds received over and above the original asset's value is considered an "exchange boot."

This can take the form of debt relief, mortgage reduction, cash profits, the exchange of real property for personal property, additional assets of value, or using funds for non-transaction costs. The presence of an exchange boot can affect an investor's tax liability on the sale, making it important to understand and minimize the risk of forming a boot during the exchange.

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Examples of exchange boots include:

●     Debt relief

●     Mortgage reduction

●     Cash profits

●     The exchange of real property for personal property

●     Receiving additional assets of value

●     Utilizing funds for non-transaction costs.

It's important to be aware of these potential exchange boots to accurately calculate your tax liability in a 1031 Exchange.

Comparing Cash Boots and Mortgage Boots in a 1031 Exchange

Two Types of Boots in a 1031 Exchange: Cash and Mortgage Boots

Cash Boots

Cash boots occur when an investor does not use all of the profits from the sale of their property to invest in a like-kind asset. For instance, if an asset is sold for $500,000 and a new property is purchased for $400,000, the remaining $100,000 constitutes a cash boot. Additionally, if the gains from the sale are not transferred to the Qualified Intermediary facilitating the exchange, it also results in a cash boot.

Mortgage Boots

Mortgage boots result from an uneven 1031 Exchange, where a reduction in mortgage or debt occurs. For example, if the mortgage owed on the replacement property is less than the mortgage owed on the original property, it reduces the overall debt and creates a mortgage boot, even if all of the sale proceeds were used to purchase the like-kind asset.

Furthermore, if the replacement property is over-financed, with a mortgage that is higher than the original property's mortgage, it also results in a mortgage boot, despite following all other 1031 Exchange rules. It is important to understand the difference between cash and mortgage boots in a 1031 Exchange to accurately calculate tax liability.

Preventing Boots in a 1031 Like-Kind Exchange

There are several ways to minimize the risk of forming a boot during a 1031 Exchange. One effective method is to work with an experienced financial planner or accountant. A professional with expertise in like-kind exchanges can help ensure that you follow all the necessary steps and deadlines, and choose assets that are truly like-kind to avoid creating a boot.

By partnering with a trusted financial advisor, you can have peace of mind that the exchange will be handled correctly, reducing the risk of forming a boot and incurring tax liability.

To make the most of a 1031 Exchange, it's essential to reinvest all the capital you earn from the sale of your investment property. If you fail to reinvest your proceeds, it disqualifies the exchange and results in a capital gains tax liability for the sale.

When planning a 1031 Exchange, it's important to consider all aspects of the transaction. Verify that neither mortgage is higher than the other and that you won't receive any cash-value assets that would result in a cash boot. Additionally, keep in mind that in some cases, you may be able to offset a mortgage boot with cash, but the reverse is not true.

By being vigilant and proactive in your 1031 Exchange, you can successfully defer capital gains and retain your wealth for future investments.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. 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. Any information provided is for informational purposes only.

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:

·      There’s no guarantee any strategy will be successful or achieve investment objectives;

·      All real estate investments have the potential to lose value during the life of the investments;

·      The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities;

·      All financed real estate investments have potential for foreclosure;

·      These 1031 exchanges are offered through private placement offerings and are illiquid securities. There is no secondary market for these investments.

·      If a property unexpectedly loses tenants or sustains substantial damage, there is potential for suspension of cash flow distributions;

·      Costs associated with the transaction may impact investors’ returns and may outweigh the tax benefits

How To Build a Diversified Real Estate Portfolio

Creating a diversified real estate portfolio involves similar principles to building a diversified stock portfolio, including selecting assets with low historical correlations and diversifying across various assets to manage overall risk. It's crucial to consider more than just geographical location, cap rates, building classes, and vacancy rates. Other real estate asset classes, as well as tax implications and liquidity concerns, should also be taken into account.

Achieving Diversification Across Asset Classes

Diversification is an important concept for any investment portfolio, and this is especially true for real estate investments. A diversified portfolio helps to manage overall portfolio risk and can potentially provide greater returns over the long term.

When it comes to real estate investing, many people automatically think of owning physical property. However, this is just one of many asset classes that investors can consider. By diversifying across different asset classes, investors can spread their risk and potentially increase the chances of achieving a successful investment outcome.

Real property is the most traditional form of real estate investing, and it involves owning a structure as an investment. Examples of real property include single-family homes, apartment buildings, and commercial properties. These assets may be able to provide a monthly income and potentially appreciate in value over time. When selecting real property investments, it is important to consider different locations and building classes to strive to help stabilize the monthly income stream.

However, investing in real property can require significant capital contributions, complex deal structures, and property management costs. For those who cannot afford to invest in physical property or for those who want to diversify further, there are other asset classes to consider.

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Real Estate Investment Trusts (REITs) come in both public and private forms. Private REITs are structured as funds, while public REITs are stocks. Unlike physical property investments, REITs are passive investments that are managed by a sponsor. REITs have the potential to pay dividends and appreciate in value.

Syndications, which are often referred to as crowdfunding. These deals are typically offered through websites, and investors can participate in a fund or a specific deal with a sponsor. Like REITs, syndications are also passive investments.

Both REITs and syndications can be further diversified by investing in either residential or commercial property. Commercial property, also known as Commercial Real Estate (CRE), can include office buildings, warehouses, storage facilities, and other commercial properties. Investing in different types of commercial properties can further diversify a real estate portfolio and help to mitigate risks.

Real property, REITs, and syndication deals can be structured in various ways, including debt and equity financing. Debt financing typically pays regular interest but does not allow investors to participate in the appreciation of the property. On the other hand, equity financing deals may not have regular payments but offer investors the opportunity to participate in the property's appreciation.

In addition to considering asset classes and deal structures, investors should also take liquidity into account.

Liquidity

It's important to consider liquidity, while real property can provide long-term value and appreciation, it may be illiquid, making it difficult to access funds quickly in case of an emergency. Publicly traded REITs, on the other hand, are generally more liquid.

Most syndication deals are not liquid, but they often have a known exit strategy, such as selling the property and returning funds to investors. By staggering these exits and diversifying across different asset classes and deal structures, investors can create some liquidity within their real estate portfolio.

Additionally, it's important to consider the type of deal structure when thinking about generating cash flow. Real property rentals, REITs, and syndications with a debt structure generally provide the potential for regular cash flows, whereas equity-only deals may not provide any cash flow. Taking these factors into account can help investors build a well-diversified and liquid real estate portfolio that targets their financial goals.

Tax Implications

Tax implications are an important consideration when building a real estate portfolio, as each asset class offers different advantages and implications. Real property may be the most complex in terms of taxes, but it also offers the most benefits. For example, real property investors can save on taxes through interest on loan payments and depreciation, which is a non-cash flow deduction.

REITs and syndications do not offer the same deductions as real property. REITs pay dividends, which may be taxed at a lower or ordinary tax rate depending on the type of dividend. Debt deals that pay interest are taxed at the ordinary tax rate, while equity deals that provide distributions are also typically taxed at the ordinary tax rate.

The tax implications of a real estate portfolio can be complex, so it is best to consult a real estate tax advisor when structuring such a portfolio.

When it comes to building a real estate portfolio, it's not just about what assets to buy, but how to create a portfolio that balances risk and returns. Even assets in the same asset class can have different risk and return profiles, depending on the specific deal. By pursuing a mix of assets that meets your needs, you may be able to balance out the risks and returns of your portfolio.

It's also important to consider that your real estate portfolio is just one part of your larger investment portfolio, which may include stocks, jewelry, collectibles, and more. If your real estate investments are causing your overall portfolio to become more volatile or putting your other assets at risk, that is something to be aware of and factor into your decision-making process. A well-diversified portfolio is key to achieving long-term financial success.

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.

Real Estate Risk Disclosure:

How To Defer Capital Gains Tax With a Partial 1031 Exchange

Want to defer capital gains tax, but also want the potential for some more cash in your pocket? A partial 1031 exchange may be the solution. Many investors rely on a 1031 exchange to defer paying capital gains. Recently, however, we have had multiple clients asking if they can do a partial exchange. The answer is yes.

When selling your investment property, the Internal Revenue Service (IRS) permits investors to reinvest a portion of their proceeds, while cashing out on the rest. Whether investors want to pull out cash to pay off debt or buy a second home, the option is available. They can then reinvest the rest per Internal Revenue Code (IRC) Section 1031, deferring partial capital gains.

Here’s a recent example. We had a client – Richard – who was selling a multifamily property in Southern California for $2.5 million. He had no debt and was ready to sell and trade into a more passive investment. However, he wanted to pull some cash out to purchase a home for his daughter. Rounding up, he needed $1.2 million, which would mean he owed nearly $300,000 in taxes, leaving just more than $900,000 for the home.

With the leftover $1.3 million, Richard had the option to either reinvest via a 1031 exchange or cash out. The tax consequence for cashing out completely would be high – and unnecessary since Richard did not need access to the cash. Therefore, Richard opted to exchange into a Delaware Statutory Trust (DST).

If the property had debt on it, additional considerations would have been necessary. Richard, however, was able to simply trade into a passive investment, defer capital gains, and buy his daughter a house.

Every situation is unique, and we are here to help investors identify an investment strategy that is in line with their objectives. Reach out to Perch Wealth to learn how a partial exchange might help you.

Not an offer to buy nor a solicitation to sell securities. Securities through Emerson Equity LLC, member FINRA and SIPC. All investing involves risk of loss of some or all principal invested. Speak to your tax professional before investing. Emerson is not affiliated with any other entity in this communication.

1031 Risk Disclosure:

·      There’s no guarantee any strategy will be successful or achieve investment objectives;

·      All real estate investments have the potential to lose value during the life of the investments;

·      The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities;

·      All financed real estate investments have potential for foreclosure;

·      These 1031 exchanges are offered through private placement offerings and are illiquid securities. There is no secondary market for these investments.

·      If a property unexpectedly loses tenants or sustains substantial damage, there is potential for suspension of cash flow distributions;

·      Costs associated with the transaction may impact investors’ returns and may outweigh the tax benefits

Investing in a REIT vs. a DST

Today’s investors have started turning to real estate investment trusts (REIT) and Delaware Statutory Trusts (DST) as alternatives to real estate investing. Each option offers a unique opportunity to enjoy the benefits of owning real estate – without the hassle of managing the property.

Although both options are considered real estate investment alternatives, they differ in specific ways. Investors who are currently or considering investing in one of these alternatives should understand the differences, the tax implications, and the potential impact on their investment portfolio.

Real Estate Investment Trusts (REIT)

“A real estate investment trust, or REIT, is a corporation that owns and/or manages income-producing commercial real estate. When individuals buy a real estate investment trust share, they are purchasing a share of the company that owns and manages the rental property.” This is known as an equity REIT.

“Most [equity REITs] focus on a specific product type (e.g., retail, hospitality, multifamily housing, senior living facilities, student housing, office space, self-storage, industrial, and so on) or geography (e.g., commercial real estate in the Northeast vs. Southwest).”

In addition to equity REITs, which invest in and manage income-producing property, are mortgage REITs and hybrid REITs. A mortgage REIT holds a mortgage on real property, while a hybrid REIT holds mortgages and owns property.

To be considered a REIT, a company must follow strict guidelines. The REIT must be an entity that is taxable as a corporation and must be managed by a board of directors or trustees. It must invest at least 75 percent of total assets in real estate, cash, or U.S. Treasuries, and derive at least 75 percent of gross income from rent or real estate sales. Mortgage REITs derive income from interest on mortgages that finance real property.

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After its first year of existence, the company must have at least 100 shareholders, and five or fewer individuals must hold no more than 50 percent of its shares.

Companies that file as REITs can avoid triple taxation by distributing at least 90 percent of their taxable income to shareholders, which results only in double taxation. The 10 percent not distributed to investors can be reinvested to acquire new properties for the portfolio.

Types of REITs

REITs can be publicly traded, non-traded, or private. The first two – publicly traded and non-traded – must register with the Securities and Exchange Commission (SEC). The major difference between these two is that publicly traded REITs are listed on a national securities exchange, offering retail investors direct access to trades. In contrast, non-traded REITS are not—investors looking for an investment that is not typically subject to stock market fluctuations generally select non-traded REITs.

Private REITs, on the other hand, are not registered with the SEC and are not publicly traded. These REITs are generally restricted to institutional investors.

Delaware Statutory Trusts (DST)

“A Delaware Statutory Trust, or DST, is a legally recognized real estate investment trust in which investors can purchase ownership interest. Investors who own fractional ownership are known as beneficiaries of the trust – they are considered passive investors.” The trust is initially created by a sponsor, who is responsible for identifying and acquiring the various real estate assets. The DST sponsor is generally a professional real estate individual or company.

“Properties held in DSTs that are considered ‘like-kind’ include retail assets, multifamily properties, self-storage facilities, medical offices, and other types of commercial real estate.”

As investors contribute to the DST, their capital replaces the initial capital used by the DST sponsor until the investors become the owners of the real estate. Unlike a REIT, where investors own a share in the company, a DST offers them direct real estate ownership.

Holding Period and Exit Strategy

Both non-traded REITs and DSTs generally require investors to hold the asset for a minimum of five years. Investors looking to liquidate prior to this may incur difficulty or additional fees.

Non-traded REITs, for example, often allow investors to sell back shares at select intervals after the second year; however, investors who select this option tend to receive only a portion of their initial investment in return. To attempt to maximize returns on REITs, it can be best to wait until the REIT changes – via a merger, outright sale, or listing (goes public).

Since DSTs offer fractional ownership, those who invest in these trusts can only liquidate their portion by selling their fractional ownership themselves or when the DST sponsor sells the asset, historically after 5-7 years. If the investor wishes to sell their share themselves prior to a sale of the property by the DST sponsor, they should understand that there is no secondary market for these trades; rather, investors usually work with a qualified professional to attempt to help identify a suitable buyer.

Generally speaking, to seek to maximize returns on DSTs, it can be best to wait until the DST has reached full cycle, meaning it has been sold on behalf of investors by the DST sponsor. At that time, investors can opt to cash out and receive any returns from their investment or trade via a 1031 exchange.

It’s important to note that there are alternative exit strategies for a DST, although the aforementioned is the most common. For example, in some circumstances, an investor could utilize a section 721 exchange to trade fractional ownership in a DST for shares in a REIT, allowing the investor to defer capital gains.

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Tax Advantages of REITs vs. DSTs

All income generated from REITs and DSTs is taxable. However, each investment is taxable in different ways.

Tax Treatment of REITs

Dividends received from REITs – which are usually paid monthly or quarterly – are taxed at different rates depending on how the income is categorized. Most dividends paid come from a REIT’s taxable income. Therefore, investors are taxed at their marginal tax rate. When a property in the portfolio is sold, however, an investor may receive capital gains distributions, which incur preferential tax rates since they are treated as capital gains.

Another way investors can receive distributions is related to return of capital – this includes distributions that exceed a REIT’s profits. Investors are not immediately taxed on this income; taxes are deferred until the investor sells their shares.

Distributions are categorized on a standard 1099 form, which every investor receives from the REIT for tax purposes.

Additionally, per the 2017 Tax Cuts and Jobs Act, REIT investors can also claim a 20 percent deduction on pass-through income until the end of 2025. This allows investors to deduct 20 percent of taxable REIT dividend income, excluding anything that qualifies for the capital gains rate.

Tax Treatment of DSTs

Like a REIT, income from DST dividends is taxed as ordinary income. Therefore, investors are taxed at their marginal tax rate. Fractional owners receive a 1099 form that outlines their pro-rata ownership of income and expenses from the DST assets.

Since DST investors are real estate owners, they can also benefit from depreciation, unlike REIT shareholders. Additional deductions may also be included.

Once the properties in the DST are sold, investors are responsible for paying capital gains. However, DSTs are unique in that they qualify for a 1031 exchange. A 1031 exchange, or a “like-kind” exchange, “represents a simple, strategic method for selling one property and exchanging it for one or more like-kind properties within a specific time frame.

The Internal Revenue Service [IRS] allows an investment property owner to exchange the real estate on a tax-deferred basis. In other words, investors defer paying capital gains through a 1031 exchange, which often equals 20 to 30 percent of their gains.”

Any investor considering selling their shares in a REIT or their ownership in a DST should consult with a certified public accountant (CPA) to understand the full tax implications.

Where to invest: A REIT or a DST?

Investments in REITs and DSTs provide individuals access to unique real estate opportunities. Those looking to replace existing real estate via a 1031 exchange should consider investing in a DST, whereas those looking to place cash have the flexibility to select from the two.

To better understand which options are best suited for your investment strategy, you should speak with a qualified professional about current investment opportunities.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. 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. Any information provided is for informational purposes only.

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:

·      There’s no guarantee any strategy will be successful or achieve investment objectives;

·      All real estate investments have the potential to lose value during the life of the investments;

·      The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities;

·      All financed real estate investments have potential for foreclosure;

·      These 1031 exchanges are offered through private placement offerings and are illiquid securities. There is no secondary market for these investments.

·      If a property unexpectedly loses tenants or sustains substantial damage, there is potential for suspension of cash flow distributions;

·      Costs associated with the transaction may impact investors’ returns and may outweigh the tax benefits

Why the Private Placement Memorandum (PPM) Is So Important

All Perch Wealth Delaware Statutory Trust 1031 Exchange real estate investments must be accompanied by a unique Private Placement Memorandum (PPM) as part of its due diligence and marketing presentations for real estate investors. However, even more importantly, Perch Wealth insists that all potential investors thoroughly read the contents of the PPM in order to get a full picture of the potential risks associated with the DST 1031 investment, and understand how the overall investment vehicle is structured.

It is crucial for all accredited investors to carefully read the entire Private Placement Memorandum, with a particular focus on the risk section, before making any investments. IRC Sections 1031, 1033, and 721 are complex tax codes, and for this reason, it is advisable for all investors to seek guidance from a tax or legal professional to understand how these codes may apply to their individual situations.

What Is A PPM?

A private placement memorandum (PPM) is a legal document that contains a comprehensive overview of an investment offering. It typically runs over 100 pages and includes information on risk factors, financing terms, property and market details, sponsor background, and financial projections. The PPM may also include exhibits such as the DST trust agreement, subscription agreements, third-party reports, lease agreements, and due diligence information like recent property appraisals.

The PPM serves to protect both the buyer and the seller of the unregistered security by providing detailed information about the investment, including industry-specific risks, to the buyer and protecting the issuer or seller from potential liability resulting from an unhappy investor. Additionally, the PPM includes a copy of the subscription agreement, which is a legally binding contract between the issuing company and the investor.

In summary, a PPM is a confidential legal document that serves as both a disclosure agreement and a marketing tool. It should provide a detailed and informative description of the investment, without using overly persuasive language. The PPM should include information on both the external and internal risks associated with the investment property, as well as potential opportunities for investors.

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Why are Private Placement Memorandums Required for 1031s?

The Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) consider DST 1031 exchange investments as "private placements" and "non-registered securities." As a result, DST investments can only be sold to accredited investors through a FINRA-registered Broker Dealer and registered representative such as Perch Wealth.

Additionally, each DST 1031 exchange investment must be accompanied by a PPM for investors to read and fully understand the investment vehicle before making a decision to invest.

Risk Factors When Investing

DSTs, like all real estate investments, come with various risks, including the potential for a complete loss of principal. Risks specific to DSTs include limited management control and the requirement for investors to assume the risk of total loss. Additionally, DSTs are typically illiquid investments. Other risks associated with real estate investments in general include natural disasters, market conditions, and early termination of leases.

As DSTs are passive investments, investors have limited control over their management. Therefore, it is crucial for potential investors to thoroughly research the company and its management team before making an investment.

The private placement memorandum (PPM) should provide detailed information about the company, including its experience in managing DST 1031 exchanges, the qualifications and experience of the management team, and testimonials from past clients. Experienced firms like Perch Wealth, with a focus on the DST 1031 market and a wide range of investment options, are highly sought after by investors.

Overview & Purpose on a PPM

The "overview and purpose" section of a private placement memorandum (PPM) gives investors an understanding of the sponsor company and how they plan to use the invested funds. This section should also include information about the sponsor's market knowledge, planned operations, and due-diligence results. This information should provide investors with a clear understanding of the sponsor's identity, investment goals, and strategies for achieving them.

PPM Conclusion

A private placement memorandum (PPM) is a vital component of any DST 1031 investment and it is essential for investors to thoroughly review the PPM before making a decision. While reviewing PPMs can be overwhelming, the industry has standardized the format of these documents to make it easier for investors to understand and compare different investments.

Working with an experienced DST 1031 exchange representative, such as Perch Wealth, can greatly assist investors in reviewing and understanding the important information in the PPM, and can be a valuable resource in making informed investment decisions.