1031 Exchange Examples

Case Studies
    Add a header to begin generating the table of contents

    Meet Howard and Lee Anne

    1031 Exchange Example:

    Reduce taxable income & increase depreciation with 1031 DST property

    Relinquished Property:

    10-unit apartment building

    Replacement Property:

    Portfolio of multifamily and net lease DST properties

    1031 Exchange Example

    About The Property Owners

    Howard and Lee Anne own a 10-unit apartment building in Seattle, which they acquired in 1992 for $850,000. In 2019, Howard and Lee Anne decided to retire and sell their apartment building, which was valued at $3,200,000 with a 3.4% return on equity, had no debt, and produced a net income of $110,000 per year. Howard and Lee Anne listed their property for sale and contacted Real Estate Transition Solutions to help them perform a 1031 Exchange.

    Their Exchange Objectives:

    Like most investment property owners, Howard and Lee Anne had multiple reasons for performing a 1031 Exchange. However, because their apartment building would be fully depreciated by June 30, 2019, their primary objective was to establish a new depreciation shelter in order to lower their annual taxable income.  

    Their Relinquished Property:

    • Their 10-unit apartment building was purchased in 1992 for $850,000.
    • Ninety percent (90%) of the value of the $850,000 purchase price was allocated to the physical structure ($765,000), and 10% was allocated to the value of the land ($85,000), which is not depreciable.
    • No capitalized improvements were made to the property.
    • Soon-to-expire depreciation allowed for Howard and Lee to benefit from $27,818 of annual depreciation for the last 27.5 years.
    • By 2019, their apartment building was valued at $3,200,000, had no debt, and was producing a net income of $110,000 per year with a return on equity of 3.4%.
    • The net sale proceeds are estimated at $3,008,000.

    Calculating 1031 Exchange Tax-Deferral Savings

    One of the first things we do when working with a client is to help them understand their gains tax liability and 1031 tax-deferral savings. Tax liability from the sale of investment real estate is not just about federal capital gains tax – it is the total aggregate amount of tax owed when an investment property is sold. Not only are investment property owners responsible for Federal Capital Gains Tax (15% – 20%), but investors may also have to pay State Capital Gains Tax (0-13.3%), Depreciation Recapture Tax (25%), and Net Investment Income Tax (3.8%).  For Howard and Lee Anne, a 1031 Exchange helped them avoid paying $733,924 in gains tax.

    Their 1031 Exchange Strategy

    One of the tax benefits associated with owning investment property is being able to deduct depreciation. However, an investment property that has been owned for several decades will eventually become fully depreciated and can no longer be deducted to help offset taxable income. That is why real estate investors often seek leveraged 1031 Exchange replacement property. However, securing a loan on replacement property can be cumbersome and may not be possible without sufficient earned income.

    With a Delaware Statutory Trust replacement property, real estate investors are able to increase their leverage and thus their annual depreciation with low-cost non-recourse debt, leading to a greater portion of their rental income being sheltered from state and federal income tax.

    Depreciable basis can only be increased by the acquisition of a higher value investment property. Without contributing additional equity to a purchase, this can be accomplished by acquiring real estate that has a higher loan-to-value than the property to be sold and Exchanged (the relinquished property). Adding debt may not be possible for an owner who is retired and may not qualify for a loan on an investment property even if they own a substantial real estate portfolio.

    However, any debt held in a DST is held at the trust level and is fully secured by the underlying real estate, as opposed to guaranteed by the owners of the property (“non-recourse”). Because the debt is held at the trust level, it does not appear on the balance sheet of the owners, but it does provide DST owners depreciation benefits.

    Because Howard and Lee Anne were retiring and needed to lower their taxable income, Real Estate Transition Solutions recommended a 1031 Exchange into a portfolio of management-free DST real estate designed to provide the potential for monthly income and increase their depreciation.

    Their 1031 Replacement Property Portfolio:

    Real Estate Transition Solutions worked with Howard and Lee Anne to design a portfolio of 5 DST property offerings consisting of 31 properties, diversified among 10 different states, for their net sales proceeds of $3,008,000 (the sales price of the property, less closing costs). The portfolio included an allocation of:

    • $1,008,000 to apartment buildings (3 DSTs)
    • $1,000,000 to value-add apartment buildings (1 DST)
    • $1,000,000 to a diversified portfolio of 24 single-tenant net-lease properties (1 DST)

    The portfolio had a total loan-to-value of 55%. All the debt was 10-year fixed-rate debt that was non-recourse with interest rates ranging from 2.84% – 3.85%, depending on the offering. The $3,008,000 of exchange proceeds acquired $6,844,444 of replacement property and thus $3,764,444 of new basis for depreciation. Ninety percent (90%) of the new basis could be depreciated.

    1031 Exchange Goals Achieved:

    By performing a 1031 Exchange into DST real estate, Howard and Lee Anne were able to sell their investment property with full tax deferral while achieving their objectives – they eliminated active property management, improved the potential for stable monthly income, and increased depreciation to lower their taxable income.

    Howard and Lee Anne’s portfolio of DST real estate produced $172,200 of annual income (a 5.59% return on equity). A 64% increase over their previous income. What’s more, the new depreciation attributed to an increased value of their portfolio – instead of zero depreciation after June 30, 2019, their portfolio produced $111,405 in annual depreciation. This means that while Howard and Lee Anne’s cash flow was 64% higher, their taxable income was only $60,795 – a decrease of 26%.

    Meet Walter and Maria

    1031 Exchange Example:

    Eliminate landlord duties & increase income potential with a 1031 DST

    Relinquished Property:

    Single family rental home

    Replacement Property:

    Portfolio of net lease and multifamily DST properties

    1031 Exchange Example 2

    About the Property Owners

    Walter and Maria own and manage a single-family rental home in San Diego, which they purchased in 1987 for $54,000. Although they enjoyed owning investment property, by 2020, Walter and Maria were ready to retire and wanted to live closer to their daughter and grandson. They worked with their realtor to get their property listed and reached out to Real Estate Transition Solutions to help them perform a 1031 Exchange into DST real estate.

    Their Exchange Objectives:

    Again, like most investment property owners, Walter and Maria had several objectives for their 1031 Exchange. However, their primary objective was to retire and live closer to their daughter and grandson, so their 1031 Advisor at Real Estate Transition recommended a portfolio of management-free DST property offerings with a focus on generating stable, monthly income for Walter and Maria. 

    Their Relinquished Property:

    • Single-family rental home located in San Diego, CA
    • Purchased in 1987 for $54,000.
    • The investment property is fully-depreciated
    • Walter and Maria have no debt on the property
    • By 2020, their investment property was valued at 700,000
    • Their property generated a net annual rental income of $36,000.   
    • Net sale proceeds are estimated at $651,000

    Calculating 1031 Exchange Tax-Deferral Savings:

    Their 1031 Exchange Strategy

    Owning and managing rental property can be rewarding in many ways, especially with great tenants, a strong economy, and low unemployment rates. However, being a landlord can also be very stressful and challenging at times – repairs can be costly and evictions can take an emotional toll on everyone involved. And in 2020, landlords experienced skyrocketing delinquencies and extended eviction bans, driving 1031 Exchange transactions into management-free DST replacement property.

    Because Walter and Maria were ready to retire from their career as landlords and needed stable monthly income, Real Estate Transition Solutions recommended a 1031 Exchange into a portfolio of management-free DST real estate designed to provide the potential for stable, monthly income. Because Walter and Maria were ready to retire from their career as landlords and needed stable monthly income, Real Estate Transition Solutions recommended a 1031 Exchange into a portfolio of management-free DST real estate designed to provide the potential for stable, monthly income.

    Their 1031 Replacement Property Portfolio:

    Real Estate Transition Solutions worked with Walter and Maria to design a portfolio of 2 DST property offerings consisting of 31 properties, diversified among different states. The portfolio included an allocation of:

    • Allocation of 60% Net Lease property and 40% multifamily property
    • Weighted heavier towards Net Lease for greater income
    • New depreciation shelter of 50%
    • $390,000 diversified portfolio of 21 single-tenant net lease properties (1 DST)
    • $261,000 in “Class A” multifamily property in Las Vegas, Nevada (1 DST)

    1031 Exchange Goals Achieved:

    By performing a 1031 Exchange into DST real estate, Walter and Maria were able to sell their investment property with full tax deferral, retire from active property management, and improve the potential for stable monthly income.

    Client portfolio example is hypothetical and for illustration purposes only. Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated. Tax rates may vary per state. Individual results will vary.

    Couple watching television smiling

    Exchange Objectives

    Howard and Lee acquired a 10-unit apartment building for $850,000 in a Seattle neighborhood on January 1, 1992. They decided to sell the property and retire in 2018. The objectives for the 1031 Exchange were as follows:

    • Monthly income potential
    • Preservation of capital
    • Defer taxes on relinquished properties
    • Diversification
    • Transition out of active property management
    • Reduce exposure to increasing landlord-tenant regulation
    • Increase depreciation to shelter income from taxes

    Property They Sold (Relinquished Property)

    Ninety percent (90%) of the value of the $850,000 purchase price was allocated to the physical structure ($765,000) and 10% was allocated to the value of the land ($85,000), which is not depreciable. No capitalized improvements were made to the property and Howard and Lee benefitted from $27,818 of annual depreciation for 27.5 years. Their depreciation benefit was set to expire on June 30, 2019.

    The relinquished property was valued at approximately $3,200,000 and was producing a net income of $110,000 per year and a return on equity of 3.4%. Additionally, there was no debt on the property. Their 2018 tax return showed $110,000 of net operating income and, including the soon-to-expire depreciation, taxable income of $82,128.

    Calculating Tax Deferral for 1031 Exchange

    1031 Replacement Properties

    The couple’s 1031 Exchange Advisor designed a portfolio of 5 DST offerings consisting of 31 properties, diversified among 10 different states, for their net sales proceeds of $3,008,000 (the sales price of the property, less closing costs). The portfolio included an allocation of:

    • $1,008,000 to “Class A” apartment buildings (3 DSTs)
    • $1,000,000 to value-add “Class B” apartment buildings (1 DST)
    • $1,000,000 to a diversified portfolio of 24 single-tenant net-lease properties (1 DST)

    The portfolio had a total loan-to-value of 55%. All the debt was 10-year fixed rate debt that was non-recourse with interest rates ranging from 2.84% – 3.85%, depending on the offering. The $3,008,000 of exchange proceeds acquired $6,844,444 of replacement property and thus $3,764,444 of new basis for depreciation. Ninety percent (90%) of the new basis could be depreciated.

    Following the exchange, not only did Howard and Lee Anne achieve their objectives of diversification, full tax deferral, elimination of active management, but they also acquired a portfolio that produced $172,200 of annual income (a 5.59% return on equity). A 64% increase over their previous income.

    What’s more, the new depreciation attributed to an increased value of their portfolio. Instead of zero depreciation from June 30th onward, their portfolio produced $111,405 in annual depreciation. This means that while Howard and Lee’s cash flow was 64% higher, their taxable income was only $60,795 – a decrease of 26%.

    Client portfolio example is hypothetical and for illustration purposes only. Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated. Tax rates may vary per state. Individual results will vary.

    Download
    FREE DST Guide

    Browse Available
    DST Properties
    DST Offerings
    Download FREE Guide
    1031 Guide Cover

    Features 28 pages with rules, tips, examples, and more.

    • * Defined by SEC as an individual with a net worth (excluding primary residence) of $1,000,000+ or annual income in excess of $200,000 for last two years for an individual or $300,000 for a couple filing jointly.
    • This field is for validation purposes and should be left unchanged.