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Exploring Replacement Options For 1031 Exchanges

by Rishav

Investors often have to deal with the rising maintenance cost on their properties, along with time. As a property grows old, it requires maintenance on a regular basis, which indirectly requires more money and time. To deal with the ever-rising maintenance cost, investors often look to sell out their properties and reinvest the proceeds in some other property or assets. Consequently, they end up paying taxes imposed by the State as well as the Federal government on the capital gains. However, on account of doing a 1031 exchange, an investor can defer up to 100% capital gains tax.

Like-kind exchange of properties eliminates capital gains tax.

A 1031 exchange is used by investors to defer capital gains tax. It is an arrangement using which you can exchange any investment property for another and defer capital gains tax. When doing a 1031 exchange, you can only involve income-producing assets. For example, you can sell a rental property for another asset that can be used for generating revenue. Unfortunately, personal properties don’t qualify for 1031 exchanges.

The term ‘like-kind’ means that properties exchanged using a 1031 exchange must be similar in nature. The majority of investors often judge this term incorrectly. Properties exchanged using a 1031 exchange just need to be similar in nature and needn’t serve the same purpose. Section 1031, in no way, requires the properties to serve the same purpose or used in the same way. That’s the reason why any investment property can be exchanged for another using a 1031 exchange.

How to choose your 1031 exchange replacement property?     

Every investment is different, and every investor has their own specific needs. The condition that suits one investor may not be good for the other. Therefore being an investor, you must know your requirements and invest accordingly. For example, if you want to get rid of the burden of property management, you can invest in a DST and complete your 1031 exchange.

A Delaware Statutory Trust or a DST is a private governing trust responsible for buying, managing, administering, and selling real estate properties. DSTs have large institutional-grade properties in their portfolios that often come with pre-arranged property or asset managers. You can buy ownership in DST properties with the help of a real estate broker or agent, who plays a vital role in locating 1031 exchange DST properties.

DSTs generally have several investors under one roof, and a single DST may have a hundred or even more investors. This is an advantage for small investors as by investing in DSTs, they can acquire large institutional-grade properties, which otherwise they may not be able to afford individually.

Locate ideal DST properties easily –

Certainly, you don’t need to get on the streets for locating 1031 exchange DST properties. You can consult a real estate broker, and they can provide you with different DST investment options. Once you’ve picked a DST in which you want to invest, you can explore the properties included in its portfolio.

Invest your 1031 proceeds in a triple net property and get relief from landlord duties.

A triple net or NNN lease is a single-tenant lease agreement that requires the tenant to pay mandatory property expenses along with the base rent. Generally, in a standard or gross lease, the tenant is only required to pay the property rent, which is then used by the investor to pay property bills like insurance fees, property taxes, etc. A triple net lease requires the tenant to pay all major property expenses instead of the investor, who, on the other hand, enjoys a free flow of income without any liability. Before exploring the benefits of investing in NNN leased properties, it’s important to understand the variation in NNN leases.

Difference between Triple, Double, and Single Net leases – 

Though a triple net lease removes all liabilities from an investor’s shoulders, a double or single net lease may provide relief to some extent. Whether a lease is a triple net, double net, or single net entirely depends on the number of property expenses the tenant must pay under that lease agreement. For example, an absolute NNN lease or just NNN lease requires the tenant to pay three major property expenses – insurance fee, property taxes, and maintenance cost.

On the other hand, a double net or NN lease requires the tenant to pay any two property expenses along with the base rent. Though the two property expenses could be any, they mostly include property taxes and insurance fees. Whereas, the investor is still required to pay the maintenance cost of the property.

Likewise, a single net lease requires the tenant to pay one property expense along with the base rent. The tenant either pays the insurance fee or property taxes, whereas, the investor looks after the other two expenses.   

What do you get with a triple net investment?

  • You don’t need to bear the landlord’s responsibilities or lose a part of your income on operating expenses. The tenant pays all operating expenses associated with your rental property.    
  • If you’ve leased a rental property under a gross lease, you can do a 1031 exchange on that asset and invest the proceeds in a triple net property. This decision will help you defer up to 100% capital gains tax. Plus, at any time, you can trade your net leased property for another asset using a 1031 exchange once again.  
  • With a net leased investment, you get big established multi-national companies like KFC, CVS, and McDonald’s as tenants. These companies often look to lease the triple net property to set up their stores.  
  • A triple net investment can help you invest in a different location. For example, if your current property is located in Texas, you can exchange it for a net leased property located in California through 1031 exchange. 

Conclusion – 

Undoubtedly, NNN investment provides many benefits to investors. However, every investor is different and has their own specific needs. Whether a NNN investment will be profitable for you or not depends upon various factors like occupancy rate, time of investment, location of the property, etc. That’s why you must consult an experienced advisor before investing. The assistance of an advisor can help you evaluate the current market situation and the potential financial risks associated with your investment.

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