Do REITs Qualify as Replacement Property for 1031 Exchange?
A REIT is a corporation or trust that owns, operates, or finances income-producing real estate. Investors purchase shares of the REIT, similar to buying stock in a company, and the REIT’s management team oversees the properties or investments.
REITs (Real Estate Investment Trusts) do not qualify as replacement property for a 1031 Exchange. This is because REIT shares are considered personal property (securities), not real property, which is a requirement for 1031 Exchange eligibility. The Internal Revenue Code (IRC) Section 1031 only allows for the exchange of real property used for investment or business purposes. This is a critical distinction for Sacramento and California investors weighing their passive real estate options.
Breaking Down Why REITs Don’t Qualify for a 1031 Exchange
Disqualification Reason 1: Personal Property Classification
When you invest in a REIT, you’re purchasing shares of a company, not a direct ownership interest in real estate.
Disqualification Reason 2: Like-Kind Requirement
A 1031 Exchange requires the exchange of one piece of real estate for another piece of like-kind real estate, which a REIT does not meet.
Alternative Options:
Using DSTs for 1031 Exchanges
For California investors seeking a tax-deferred real estate reinvestment option, Delaware Statutory Trusts (DSTs) are a popular alternative. Per IRS Rev Ruling 2004-86, DST interests do qualify as replacement property in a 1031 Exchange.
Utilizing a Section 721 Exchange
Investors interested in transitioning to a REIT structure can explore options like UPREITs (Umbrella Partnership REITs) or a 721 Exchange, which may offer a pathway to exchange real property for REIT shares. IRC Section 721 provides an alternative strategy to defer capital gains taxes on the property sale. A 721 Transaction is completed when an individual contributes an investment property to the operating partnership of a REIT. Instead of receiving cash for the sale of the property, the investor receives OP Units of the operating partnership in the UPREIT structure.
Read more about UPREITs and 721 Exchanges →
At Legacy, we work with you to build an investment strategy tailored to your unique goals, needs, skill level, and finances. Give our knowledgeable team a call to learn more about the IRS-approved replacement property options available to you.
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There are material risks associated with investing in private placements, Delaware Statutory Trusts (“DSTs”) and real estate securities including the potential loss of the entire investment principal, illiquidity, tenant vacancies impacting income and revenue, general and real estate market conditions, lack of operating history, interest rate risks, competition, including the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and investors should read the PPM carefully before investing paying special attention to the risk section. This material is not to be interpreted as tax or legal advice. Please speak with your own tax and legal advisors for advice/guidance regarding your particular situation. Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Advisory services offered through Concorde Asset Management, LLC (CAM), an SEC registered investment adviser. Legacy Investments & Real Estate is independent of CIS and CAM.