Case Study: 3 Steps to 1031 Exchange into a REIT

The question of whether you can 1031 exchange into a REIT often elicits a mixed response: technically, yes, practically no. However, recent developments have opened new avenues, allowing investors to utilize a 1031 exchange to enter REITs with as little as $250,000, provided certain guidelines are followed.

Step 1: Using Delaware Statutory Trusts (DSTs) in a 1031 Exchange to 721 Exchange & 721 UPREIT

Traditionally, REITs weren’t interested in individual properties due to their size relative to portfolio needs. Now, some large REITs facilitate a pathway through Delaware Statutory Trusts (DSTs). Here’s how it works:

1. The REIT establishes a temporary DST, enabling the 1031 exchanger to acquire an interest.
2. After a suitable period, typically when the DST’s investment horizon concludes, the REIT integrates the DST into its portfolio, bringing the DST investor along.
3. At this stage, the investor effectively becomes a shareholder in the REIT.

Step 2: A Case Study with Billie

Let’s examine how this strategy played out for Billie, a client pivotal to our development of DST expertise. When Billie’s initial DST reached maturity in November 2021, yielding her original investment plus profits, we swiftly initiated a new 1031 exchange with her Qualified Intermediary. In July 2021, upon learning of the DST’s impending sale, we guided Billie through her options:

1. Receive the proceeds outright, triggering taxes on the entire amount.
2. Reinvest a portion of the proceeds, paying taxes only on the non-reinvested portion.
3. Reinvest the proceeds, deferring taxes entirely, per the 1031 exchange provisions.

Billie opted for the second option, withdrawing approximately $100,000 as ‘boot,’ taxed at a reduced rate, and reinvesting the balance. This led to a critical decision point: whether to reinvest in a traditional DST or the more advantageous 721 DST.

Step 3: Advantages of the 721 DST

The 721 DST emerged as Billie’s preferred choice and our recommended strategy due to its unique benefits:

• Enhanced diversification across multiple REITs compared to single DST investments.
• Potential for continued tax deferral through subsequent DST rollovers.
• Mitigation of risk associated with concentrated asset holdings.

As Billie’s remaining DSTs mature, we plan to transition these investments into 721 DSTs, ensuring a well-rounded REIT portfolio. This modern approach wasn’t available when Billie initially invested, underscoring the evolving landscape and strategic opportunities now accessible to investors.