Exploring 1031 Exchange Investment Options: A Guide for Investors

Any real property held for investment or for use in a business can be exchanged for any other real property held the same way. A rental house can become an apartment building, a strip center, farmland or an interest in a Delaware Statutory Trust. "Like-kind" is much broader than most people expect.

Here are the most common options and what to keep in mind with each.

Single-family rentals

Easy to finance, easy to understand and easy to sell later. Many investors exchange one larger property into several houses, or several houses into one. If you're buying more than one, keep the identification rules in mind (more on that below).

Multifamily

Duplexes up to large apartment complexes. More units spread out vacancy risk and can make professional management worth the cost. If you plan to live in one of the units, that unit is your residence and isn't part of the exchange. The investment portion still qualifies.

Commercial property

Retail, office, industrial and net-leased buildings. Leases are often longer, and with a net lease the tenant may cover taxes, insurance and maintenance. Tenant credit and lease terms matter a lot here, so lean on your broker and attorney during due diligence.

Delaware Statutory Trusts (DSTs)

A DST lets you own a fractional interest in a larger property that a sponsor manages. The IRS treats a properly structured DST interest as real property for 1031 purposes. DSTs are securities, sold through licensed representatives and usually limited to accredited investors. They're also illiquid, carry fees and don't guarantee distributions. Some investors use a DST for part of their proceeds as a backup in case a direct purchase falls through.

Vacation and short-term rentals

These qualify if you hold them as investments. If you plan to use the property yourself, the IRS safe harbor looks at both rental and personal use. Rent it at fair market value at least 14 days a year, and keep personal use to 14 days or 10% of the days rented, whichever is more.

Raw land and farmland

Land qualifies, and so does farmland. Raw land usually produces little or no income, so think about how you'll carry it. You can also exchange land for a building, or a building for land.

New construction and build-to-rent

You can buy a newly built property as long as you close on it by day 180. A builder's delays don't extend that deadline, so build some cushion into the schedule. If you want to use exchange funds to build or improve, that's an improvement exchange, which is set up differently. Only improvements completed by day 180 count toward your replacement value.

What to think about before you choose

• Value and debt. To defer all of the tax, buy at least as much as you sell and reinvest all of your net equity.

• Identification. You can identify up to three properties of any value, or more than three as long as their total value doesn't exceed 200% of what you sold.

• Timing. You have 45 days from your sale closing to identify and up to and including day 180 to complete your replacement purchase or purchases.

• Your goals. Cash flow, appreciation, less management, a different market. The right property depends on what you want it to do.

Next step

Talk with your tax advisor about which option fits you, and loop us in early so we can help you plan around the timeline.

APX 1031 is a Qualified Intermediary. We don't provide tax or legal advice; talk with your CPA or attorney about your situation.