On the downside, the amount is a significant portion of her net worth, which Studin is reluctant to tie up in a single property. "If we could get diversification and find properties where the economics are favorable, I might suggest it. So far, though, I haven't found anything that works, so I may recommend that she pay the tax."
One other issue that can be a problem for 1031 exchanges: timing. To qualify for tax deferral, a seller must identify replacement properties, in writing, within 45 days of the sale. Up to three possible replacements can be named; more than three can be named if the total value is no more than twice the value of the sold property. Perhaps more difficult, the new property generally must be acquired within 180 days.
"As a backup," Jordan says, "I'd suggest putting a professionally managed deal on the list, if an attractive one is available. Then, if buying a particular replacement property within the time limit isn't possible, the seller can defer the tax by buying into the multi-owner deal."
Such co-ownership ventures, actually private placement securities, are not just for deadline desperation. "Co-ownership offerings are especially attractive for real estate owners who have held the property for quite a while and no longer want to deal with the so-called Three T's - tenants and trash and toilets," Ju says. "The owners may be relocating, so they don't want to manage their old properties long distance, but they also don't want to be hands-on managers in their new area."
These deals typically involve one or more high-value, institutional-grade parcels, such as retail space leased to a chain. The deal's sponsor is responsible for property management, and the deals are usually structured so that multiple owners are involved; often they're designed to attract investors pursuing a 1031 exchange. "They usually pay cash flow to investors," Ju says, "often in the 6% to 7.5% range these days." As with any type of sponsored deal, there are costs, so investors might see lower returns than if they dealt with the Three T's themselves.
Multi-owner exchanges became popular about a decade ago, often with a tenancy-in-common structure. Now, Ju says, TICs have been largely replaced by Delaware statutory trusts. "The main reason relates to financing," he says. "Banks today don't want to do a credit check on each individual owner, as they had to do with a TIC offering. With a DST, the bank makes one loan, to the entity owning title to the property or properties."
To a property owner, the deals look similar: tax deferral, cash flow and passive management. However, as Ju points out, a DST investor has less control over the properties than in a TIC. "The trustee decides when to sell a property, for example," he says. With the TIC structure, investors have the right to vote on sales and refinancings.
Ju concedes DST interests are illiquid, but says that's true for any property investment. "With a DST, at least, you may have 50 other owners who are familiar with the real estate," he says. "At the right price, one of those owners might be willing to buy an interest from someone who wants cash."
Donald Jay Korn is a Financial Planning contributing writer in New York. He also writes regularly forOn Wall Street.