And we are privileged to be joined by Invesco real estate exchange specialist Kyle Connor here on the program. Kyle, you've got an interesting program that allows investors with appreciated real estate holdings to maybe divest out of their current real estate holdings, reinvest capital, and continue to defer paying the taxes on the capital gains. This is important for real estate investors to be aware of this opportunity, I feel.
Yeah, no, definitely. And again, Peter, I appreciate you letting me join today and thanks for everybody listening. So yeah, so today, I'll be talking about 1031-721 exchanges, which is a unique solution specifically for clients that own appreciated real estate and want to sell those properties, but would like to defer those capital gains and all those taxes via 1031 exchange, and ultimately end up into a diversified portfolio of high quality real estate, again, on a tax deferred basis, which can lead to an ease when it comes to estate planning, or for potential if they were looking for some liquidity down the line to manage that tax liability over a number of years. So we'll delve a little bit deeper into the 1031 exchange key requirements, what to consider when executing these exchanges, talk a little bit more about these these types of solutions that are in market, and some of the benefits that we can touch on as well. Now, I think most of the listeners to our program or viewers of the podcast probably have some real estate exposure. I think real estate investment is part of most any proactive saver and investors portfolio. But there is a difference between your primary residence versus investment real estate. And so there's tax advantages on either side with your primary residence, there is the capital gains tax exemption, if you sell your primary residence, you are allowed as an individual or a married couple to have certain amounts of gains up to 250 or 500,000 without paying capital gains on that profit.
And, and that is a great wealth building tool and opportunity. However, what we are talking about is specifically not the primary residence, not the roof over you and your family's head. These are investment properties investment real estate holdings, such as retail or office space or rentals or farmland, those would all fall into this category where I think Kyle, the investor that may have between two or $10 million or more in net worth many of them have diversified a portion of their portfolio into some kind of investment type real estate.
Yep, that's exactly correct. And so yeah, the types of real estates that are eligible for these light kind exchanges, or these 1031 exchanges. And so for the ability to execute the 1031 exchange, to your point, Peter, that it does need to be a property, if you see on the right side of the screen that's used for business trade or investment purposes.
And that's considered like hot. And so like kind is a very broad definition, meaning it can be apartment buildings, farmland, raw land, retail, single family rental, manufactured homes, oil and gas royalties for those down in Texas water mineral rights. And in this type of solution, we utilize what is called a Delaware statutory trust, otherwise known as a DST that also constitutes as a light kind replacement property. And so there are some other specific guide, kind of key requirements to, to followed in order to execute that exchange.
So number one, again, it is that light kind property that is eligible. The number two, before you sell that property, it is very important to engage with a qualified intermediary, also known as a QI or the exchange accommodator that essentially when the client sells the property, the proceeds must flow directly to the qualified intermediary in order to successfully execute the exchange. If the client was to take constructive receipt of those proceeds that actually blows up the exchange.
And there's no going back from that. The other key things that I'll just mention real quickly too, is that it's really important to engage with a CPA as well on the front end and make sure it also makes sense for you to sell your property and defer those taxes via a 1031 exchange. Maybe I'll make a big, quick disclaimer as well that neither myself or anybody at Invesco does provide tax advice. So please be sure to connect with your tax professional.
But the last component that I'll mention that are some of the key requirements is specifically regarding the shot clock or the time requirements. So once that property is sold, the client has 45 days to identify replacement property and 180 days to execute into the new replacement property. And then lastly, the new property must be equal to or greater than in value than the relinquished property sold. And 100% of the proceeds must flow into one or a multitude of like kind properties. So that means that if the client is selling a property for a million dollars, the replacement property must be at least a million dollars. And 100% of the proceeds must be exchanged into one or a multitude of those like kind properties.
Well, all right, let's talk about a few different factors there. The timeline, the proactive necessity of identifying a replacement property, and then the actual proceeds, the amount, the tax ability of all those. So A, number one, there are specifics for the timeline of all of this, and there is a requirement to identify that replacement property within that timeline. There are strategies, however, in keeping with the 1031 and the 721 exchange that allow the actual holder of the original investment real estate to sort of relinquish some of those constraints and responsibilities.
That's exactly correct. And so, you know, in this type of solution, so in the 1031-721 exchange market, if you're a client and you're at that point in time where you're looking to sell that piece of real estate, you know, maybe you bought it 20, 25, 30 years ago, you've got a basis that's probably at about zero, and you're looking to sell it for, let's call it $3 million or so dollars. And if you sold it outright, you're going to have a massive kind of taxable event.
And so you're looking to not have to pay those taxes. So you want to execute 1031 exchange, but you don't want to just 1031 exchange into another active or another real property, because you're just at that point of time where you don't want to be an active landlord and manage the three T's of real estate, tenants, toilets, and trashes. And so if you're looking for a solution for a bit more of a passive approach, that's where these Delaware statutory trusts can come into play. And again, the goal of this type of solution is for a client that's looking for a bit more of a passive approach to real estate, but really wants to defer their taxes, can utilize this 1031 721 exchange structure to end up into a diversified REIT on a tax deferred basis.
And so there's really three unique phases. There's the offering period on the left side, there's the DST phase in the middle, and then on the right side, this is where there's a fair market value option to get into the operating partnership units of the REIT. And so during the offering period, this is again, where we call our sponsors will bring to market a Delaware statutory trust that holds commercial real estate properties.
And they're essentially selling off for actual interest of this trust to match your client's 1031 exchange needs. Once they execute that exchange into the DST, they will immediately start to accrue and receive the cash flow from the underlying properties in the DST. Typically, the DST phase, this middle phase will last a minimum two years to be compliant with the internal revenue code.
Typically sponsors will say roughly two and a half years or so because it may take six to nine months to close out the offering. However, they will receive and accrue those cash flows before the offering is fully syndicated. And typically in the DST phase is a quarterly cadence, so they're going to be receiving quarterly distributions, quarterly statements, and then the annual tax form is a substitute 1099.
And then the 721 exchange comes into play. And this is where essentially the REIT that is attached to this program has a fair market value option where the sponsor goes out and gets an independent third party appraisal, has the ability to exercise that option by acquiring the properties at fair market value and converting the DST beneficial interest into operating partnership units of the REIT on a tax deferred basis. And the reason it's the partnership units is for the benefits of tax referral.
That's why they, the sponsors won't issue common stock, but think of the partnership units in common stock is essentially economically equivalent depending on which underlying shared class you receive. Once they end up into the REIT, they will typically have to hold those partnership units a minimum one year. So it is an illiquid investment, call it minimum three to roughly three and a half years or so. But at that time they are getting into a full diversified portfolio. They do have the ability to access some liquidity if they're looking to do so, after that kind of three year lockup period.
And it is a great estate planning tool too, if they're looking to park it and utilize it as a way to pass on to their beneficiaries. And the last thing that I'll just mention on this page too, is that typically when you end up in the REIT, it does change to a monthly cadence. So you'll receive monthly distributions, monthly NAV, monthly statements and monthly liquidity profile. And typically you're going to see a bit more of that capital appreciation or total return benefits in the operating partnership phase or the REIT phase relative to more just stabilized income during the DST phase. And Kyle, in order to execute on this strategy, prior to the combination of these two different parts of the tax code, an investor doing a 1031 exchange exclusively would have to find a property that is almost exactly of equivalent value if they did not want to either take a taxable distribution upon the sale of the original property or have to potentially come up with a large additional investment to purchase an exchange into a property of greater value. Again, this strategy takes that responsibility of either taking an unwanted taxable distribution or coming up with additional investment capital off of the shoulders of the investor.
That's a really good point. So let's go back to that example where you've got a client, they're selling a $3 million property, and maybe this client, they still are at that point where they do enjoy being a real estate landlord and they'd like to get their hands dirty and fix up the property. And so they want to defer those taxes via a 1031 exchange, but they do want to go into another real property. But let's say the property they found is only worth $2 million. Well, you've still got a million dollars worth of proceeds that you need to find a like-kind property to place into if you want to defer 100% of your taxes. In that type of solution, let's say they defer the $2 million into a real property, but they've still got a million left. The nice part about a Delaware statutory trust is that it can right size your investment. Given that these DSTs, again, you've got commercial real estate properties, typically they're around 50 to $100 million offerings. And so you've got this large offering and they're just selling off a fractional interest to match your need. So if you only needed a million dollars, the DST can essentially right size it to help you defer those taxes and right size that investment. On the flip side, to your point, if they needed to upsize. So that's a part where, again, if you've got a client that let's say they're at they're at that point where they just wanted to further taxes, that's the biggest number one draw to the 1031 exchange. And they don't want to like, they may want to go into a real property, but they're not really finding anything. Maybe it's a little bit more expensive. They don't want to add an extra million dollars of cash to buy that investment.
And so instead they found a DST. And then again, in that scenario, they can just right size it to help defer their taxes. Now, would the original investor have the ability to take some distribution or cash flow upon the time of the transaction or in that period of illiquidity? So in so let's say the client, again, three million dollar example, let's say they wanted to take as they sell the property $500,000. So they're only going to defer the 2.5 million. Well, that $500,000 is considered boot and is a taxable event.
It will be prorated. So you're not instead of selling a property, getting your full proceeds and paying your lump sum of taxes in that scenario, you would just pay a portion of it. Now, if you could wait the three years in this type of 1031 721 exchange solution, you can get it down the line. Now, typically it is illiquid for that minimum three year hold. So once you exchange it into you will have to wait till the one year after the partnership units in the REIT to access some liquidity.
But most REITs and typically these are attached to non traded REITs or publicly but non listed REITs that have some illiquidity restraints, typically at two percent of any V per month, five percent of any V per quarter. But in theory, again, down the line, they could access some liquidity prorate some of their it would be a prorated tax bill or they could work with a financial advisor like yourself and potentially harvest some losses. You know, again, the bulk of what we're deferring is capital gains. So in that scenario, if you sold a portion again, let's say you sold one hundred thousand dollars worth of your partnership units, which you'd have a prorated tax bill, but you harvested one hundred thousand dollars of losses in some of your other kind of traditional portfolio, you have the ability to offset or mitigate that tax liability down the line as well.
Nobody likes losses, but they're sometimes can be a use for them or a silver lining way to leverage them. And we talk about tax loss harvesting with with investors who are just in the market. But the same is true here when we are talking about these real estate exchanges and the DSTs, the ten thirty one seven twenty one combination. However, Kyle, where I really see this as an opportunity, we have a lot of family farmers throughout this area who are quickly passing the baton on to the next generation, maybe not so interested in running the family farm and selling off to developers. A lot of times these are pretty high dollar property sales. They are generally investment property sales that would qualify for this. Maybe the beneficiaries don't want to or don't all agree on what to do with the family farm or the original owner just wants to alleviate them of having to make that choice and responsibility knows that they aren't going to be equipped to do it ahead of time.
This is a great opportunity for estate planning, whether family farm or other type of real estate investment. No, that's spot on. And so I think that the big draw. So, again, number one, the people the reason why people use this type of solution is to defer your taxes.
That's going to be your number one benefit, of course. But I'd say that a close second is really for that estate planning purposes. And so the great part about any type of real estate, whether it be a Delaware statutory trust or these partnership units or just actual real real estate is that when an investor passes away, their beneficiaries will get a step on basis.
They can then sell that property and then ultimately pay no taxable event at that time of passing. Well, so what we help what this solution helps solve for is the divisibility aspect of these partnership units. And so in that scenario, if you've got a client and they've got three heirs and they know that one of the heirs likely wants to keep the farm, the other heir wants to potentially sell it, and the third heir doesn't really know what they want to do with it.
Well, you have the potential of three children fighting in the wake of their parents passing, which nobody wants, but unfortunately happens more often than not. And so how this solution helps solve for that is ultimately an easy, divisible way to pass along these partnership units to their heirs at the time of passing. Again, they get that step on basis, but each heir will get their divided interest of these operating partnership units and then can have their own independent decisions on what they'd like to do with it. If one wants to sell the partnership unit, they can sell it and go and invest it with whatever they'd like to do. If another one likes the reed, they can stay in the reed and continue to have that grow over time. And so it allows for a bit more of an easy way to pass along to your heirs. And again, just a way for a lot of clients to be able to help solve for these kind of unique scenarios as we get later in our lifetime. And again, if those heirs do not want to own that property or have the property.
Now, pros and cons to every approach here. If I was that original land or real estate investment, real estate owner, thinking about my estate and passing it to beneficiaries, if I sell off during my lifetime, hey, I've got to deal with the tax implications, right? If I do not, then the beneficiaries do receive that stepped up cost basis. But at the same time, they are also left with that potential infighting of what to do with the property after I am gone.
And nobody wants to leave a fight for their children or their beneficiaries. So this is a solution that helps to mitigate and balance those two. However, Kyle, could you talk to us about what if one of those recipient beneficiaries then wants to ultimately get out of this and maybe into another type of investment real estate with their portion of the proceeds? How does that work in exiting this? So essentially what happens is that, again, so you're the the investor who owns the property has executed their exchange. Now, three years down the line, they're in these partnership units.
They're generating income, they're generating some upside potential from the sponsor, you know, executing on their business plan inside the read or inside the portfolio. And then ultimately the investor dies. They've got three beneficiaries. Each beneficiary is going to get that step up and basis, as we stated, and he's going to get their divided interest. Now, let's say that one wants to sell all of their proceeds.
And so they would then issue a statement to the to the reader. To allow to liquidate. And again, there is that threshold of two percent of any per month, five percent of any per quarter. But as long as everybody is not rushing to the gate at that time, the ability to likely get the entire proceeds out in full, they'll be able to do so. And again, there will be no taxable event given that step up and basis. And then they're going to get their proceeds and they can choose to do what they like with those, you know, at that time. And then because of the stepped up in cost basis, they would at that point in time only be responsible for tax on the appreciation from the time of the original owners passing to the date that they choose to sell it, correct?
That's correct. And so, again, the nice part is that during the DST phase of this type of investment, you know, the sponsors strike a quarterly NAB. The sponsors strike a quarterly NAB. Now, during the REIT phase, they strike a monthly NAB. So the nice part about that is that at the time of the investors passing, the sponsor is going to know exactly what that true step up and basis will be given the striking of the NAB that's called on that monthly basis during the REIT phase. And if they waited, let's say, an extra month to liquidate, let's say in that one month, if there was a little capital appreciation, then yes, there would be a taxable event on that appreciation.
But if they were to get out in the same month that they struck that NAB, then it's going to be a completely step up and there'd be no taxable event in that scenario. With the potential changes to tax law that can occur, may occur into the future, it's always kind of good to be proactive in planning. And especially if you've got a large portion of investable assets that is in some kind of investment real estate, this could be a very effective tool for you to plan proactively, both for the eventual sale, if you do not intend to keep that piece of property or those pieces of property forever and ever, but don't want to pay the capital gains tax on it immediately or for estate planning purposes. And Kyle, your real estate exchange specialist, well versed in this area, can help a planner put all of that together.
Kyle Newsome Yes, definitely, Peter. And again, my sole job is to help advisors, clients, whether it be bringing in the qualified intermediary and the CPA or the exchange accomitor, all these parts because there is a lot of components that need to work together in order to execute a successful exchange. And so ultimately, my goal here is to always help out any way I can. And please feel free to reach out to myself and Peter for any type of more, whether it be educationals or want to learn more about this type of solution, if it seems right for some of your clients and investors out there.
So always happy to help. Peter Bell Kyle Connor with InvestGo. He is a real estate exchange specialist. And today discussing the combination of the 1031-721 strategies to help real estate investors with investment real estate to properly and effectively manage the taxes when eventually getting out of that or getting into or exchanging to the next piece of investment real estate. An effective way to do that, to right size it, that really addresses many of the, I will call it, clunky problems with the traditional 1031 exchange process.
Peter Bell Yep, that's exactly it. Again, this type of solution is Delaware Statutory Trust. One thing I should talk about the market just real quick is that it is growing in size. And so this year, this syndicated 1031 exchange world is about to be around 5.2 billion, which will be the third largest year on record. And so these types of solutions, especially with an aging demographics and people that are looking for those tax deferral exits, it really sought out. And again, it's an easy way and that's where it's very important to engage with high quality sponsors that can manage those proceeds in the best of their ability on your behalf.
But again, it's a great way to help defer those taxes, utilize a potential right size your investment to execute that 1031 exchange, and then use it for the estate or tax planning benefits down the line. Again, Kyle Connor, with Invesco, we appreciate the time and the insight and knowledge into this aspect of financial and investment management and planning. Thanks again, Peter. Really appreciate you taking it on.
Thanks again. Hey, folks, Peter Rochon here with Rochon Planning. So glad that you are enjoying the podcast Planning Matters Radio. You know, one of the tools that we've put out there that people really seem to appreciate and really are our finding of value is at 919retired.com. It is your retirement tax bill calculator. If you've got any kind of retirement account, your tax deferred 401K or IRA, this is the website.
This is the resource where you can go. You can plug in your own numbers, your information. You can slide the the the tool calculator up and down for your tax rate or your amount of savings and see what your tax bill is likely to be if you default and defer to the IRS's plan versus what you could potentially bring that tax bill down to. A lot of times it is a very significant savings.
So if you have not yet, go to the website 919retired.com. Run your numbers on the retirement tax bill calculator. This has been Planning Matters Radio. The content of this radio show is provided for informational purposes only and is not a solicitation or recommendation of any investment strategy. You are encouraged to take investment, tax or legal advice from an independent professional advisor. Any investments and or investment strategies mentioned involve risk, including the possible loss principle. Advisory services offered through Brooks Home Capital Management, a registered investment advisor fiduciary duty extends solely to investment advisory advice and does not extend to other activities such as insurance or broker dealer services. Advisory clients are charged a quarterly fee for assets under management, while insurance products pay a commission, which may result in a conflict of interest regarding compensation.
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