1031 Exchanges
You don’t have to buy a replacement investment property.
Thornwood Financial offers access to 1031 Exchange—compatible investments that allow clients to defer capital gains taxes on appreciated real estate—without the burden of purchasing and managing a new property themselves.
Our platform contains investments sponsored by national real estate that qualify as replacement properties for a tax-deferred 1031 Exchange. With these structures, an investor owns an undivided interest in an institutional-grade income-producing property.
Along with deferring taxes on the relinquished property, investors may benefit from monthly cash flow generated by ongoing leasing activity, as well as potential long-term appreciation—all without the headaches of day-to-day property management. No tax is due until the replacement property is eventually sold, typically after a 5–10 year holding period.
At that time, the investment can be exchanged again to continue deferring taxes. And if the investor passes away while still owning the property, heirs may receive a stepped-up cost basis—meaning the previously deferred tax may never come due.
The Details
Like-Kind Property
“Like-kind” refers to the type of real estate being exchanged. You can exchange any investment property for any other investment property—for example, vacant land can be exchanged for a rental property. Your personal residence does not usually qualify as like-kind property.
In many cases, you can also exchange one property for multiple replacement properties. The three-property rule allows investors to identify up to three potential properties, offering an opportunity for diversification within the exchange.
Remember, diversification does not guarantee profit, or protect against loss in a declining market; it is simply another method of managing investment risk.
EXCHANGING UP
To complete a fully tax-deferred exchange, the general rule of thumb is to exchange “even or up”—both in total value and in the amount of equity and debt carried into the replacement property.
BOOT
“Boot” refers to any portion of your exchange proceeds that is not reinvested into a qualifying replacement property. If you fail to exchange an equal or more value, equity, or debt, the difference is considered non-qualifying property—also known as boot.
If boot is received, the taxable amount is based on the lesser of the realized gain, or the amount of boot received.
The Dos and Don’ts of a 1031 Exchange
DO plan ahead. Talk with your accountant, attorney, broker, financial planner, lender, and Qualified Intermediary before initiating an exchange.
DO remember the three core rules for tax-deferral eligibility:
Invest only in “like-kind” replacement property or a qualifying real estate investment.
Use all proceeds from the relinquished property toward the replacement property or qualifying investment.
Ensure the debt on the replacement property is equal to or greater than the debt on the relinquished property. (A reduction in debt can be offset with additional cash; a reduction in equity cannot be offset by increasing debt.)
DO attempt to sell before you buy. If you find the ideal replacement property before selling your relinquished property, a reverse exchange may be required. These are possible, but carry additional risks due to the IRS’s strict timelines and parameters.
DO
DO NOT try to complete a §1031 exchange using your attorney or CPA to hold title or funds. IRS regulations require a Qualified Intermediary to properly structure and complete the exchange. Contact us if you need a reputable intermediary in your area.
DO NOT dissolve partnerships or change the manner of holding title during the exchange. Any change in the exchanger’s legal relationship to the property may jeopardize the entire transaction.
DO NOT miss your identification or exchange deadlines. You must identify your replacement property within the 45-day identification period and acquire it within the 180-day exchange period. Missing either deadline will disqualify the exchange, resulting in the sale of the relinquished property becoming fully taxable. Reputable intermediaries will not act on back-dated or late identifications.
DO NOT
Delaware Statutory Trusts (DSTs)
A Delaware Statutory Trust (DST) is a separate legal entity formed under Delaware law. When structured according to IRS guidelines, it qualifies as a grantor trust, allowing accredited investors to use beneficial interests as replacement property in a 1031 exchange.
DST Structure
Investors own beneficial interests in the trust.
The managing Trustee (usually the Sponsor or an affiliate) oversees operations.
The DST holds 100% title to the property.
Accredited Investor Requirement
DSTs are available only to accredited investors, typically defined as those with:
$1 million net worth (excluding primary residence), or
$200,000 individual / $300,000 joint income for the past three years, or
Active Series 7, 82, or 65 licenses (Series 66 does not qualify).
Consult a CPA or attorney if unsure about accreditation.
Tax Reporting
Investors receive Schedule E reporting using sponsor-provided operating information.
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The DST structure does allow for the investors or beneficial owners to conduct their own 1031 tax deferred exchange once the DST has liquidated its assets (i.e. sold the property)DST 1031 properties are only available to accredited investors (typically defined as having a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last three years; or have an active Series 7, Series 82, or Series 65. Individuals holding a Series 66 do not fall under this definition) and accredited entities only. If you are unsure if you are an accredited investor and/or an accredited entity, please verify with your CPA and Attorney.
Tax reporting for a DST is done on a schedule E utilizing property operating information provided by the sponsor.
The IRS issued the Revenue Ruling 2004-86 that set forth parameters a DST must meet in order to be viewed as a grantor trust and qualify for a tax viable tax deferring vehicle. If the DST is structured responsibly, the parameters do not prohibit a successful business plan for a property. The following is a list of the parameters and the procedures generally accepted to comply with these limitations.
IRS Revenue Ruling 2004‑86: DST Compliance Parameters
To ensure DSTs remain eligible for 1031 treatment, the IRS requires:
No acquisition of new assets (other than short‑term obligations)
Cash from the property is held in liquid, money‑market‑type accounts
No additional capital contributions or capital calls
No refinancing or renegotiation of existing loans
No renegotiation or signing of leases with tenants
No major structural changes (only routine turnover permitted)
All cash distributions are made to beneficiaries, except for reasonable reserves
No reinvestment of sale proceeds into new property
Springing LLC Provision
If a loan matures before the property is sold, the DST may convert into a Springing LLC, allowing refinancing or major capital improvements. This action typically limits the investor's ability to complete a subsequent 1031 exchange.
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The list of potential benefits and drawbacks of a DST is not all encompassing. There are material risks associated with investing in real estate securities including illiquidity, general market conditions, interest rate risks, financing risks, potentially adverse tax consequences, general economic risks, development risks, and potential loss of the entire investment principal.
Institutional-grade properties generally refer to a property of sufficient size and stature to merit attention from large national or international investors, and typically have the characteristic of high-quality assets in major markets and at price points beyond the reach of individual investors and smaller partnerships.
Our goal is to help you trade the headaches of active management for institutional-grade income potential, keeping your equity working while you enjoy the freedom you’ve earned.
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