The 1031 exchange rule allows investors to defer capital gains taxes when selling an investment property and reinvesting in another property. This tax break encourages continued investment in real estate while giving investors more flexibility. When considering 1031 investment options, investors should focus on finding replacement properties that fit their risk tolerance, diversification needs, and growth potential. The most popular 1031 exchanges are into rental real estate, Delaware Statutory Trusts (DSTs), real estate investment trusts (REITs), and triple net leased properties. By understanding the pros and cons of these alternatives, investors can make informed decisions when weighing 1031 investment options.
Rental real estate provides cash flow and appreciation but requires active management
One of the most common 1031 exchanges is swapping one rental property for another. This allows real estate investors to continue earning rental income while deferring capital gains taxes. Rental properties can generate cash flow from monthly rents and appreciate in value over time. However, directly owning rental real estate also requires ongoing property management, maintenance costs, and dealing with tenant headaches. Investors must weigh the higher returns potential of direct ownership with the responsibilities of being a landlord.
DSTs provide passive real estate ownership with minimal involvement
Delaware Statutory Trusts (DSTs) have become popular 1031 exchange options for investors who want to own institutional-grade real estate passively. DSTs own commercial properties like apartments, office buildings, and medical facilities. By purchasing a share in a DST, investors can gain exposure to a diversified real estate portfolio without having to actively manage the properties. Cash distributions come from the rental income generated by the properties. The main downside is that DSTs have high upfront fees and no liquidity outside of arranging another 1031 exchange.
REITs offer liquid real estate exposure with steady dividends
Real estate investment trusts (REITs) are companies that own and manage income-generating real estate. They are exchanged-traded securities that offer investors an easy way to gain exposure to real estate without direct ownership. Popular REIT sectors include retail, office, industrial, residential, and healthcare real estate. REITs pay 90% of taxable income as dividends to shareholders. A key advantage is that REIT shares are liquid and can be sold at any time without requiring another 1031 exchange.
Triple net leased properties provide stable income with fewer risks
Triple net leased properties are fully occupied by tenants who pay all real estate taxes, insurance, and maintenance expenses in addition to rent. The leases are typically 10-25 years with contracted rent increases, providing very stable cash flow. These long-term leases with creditworthy tenants lower the risk compared to traditional multi-tenant properties. While triple net leased properties have less upside potential, they generate reliable income without management headaches, making them attractive 1031 exchange options.
The four most popular 1031 exchange investments are rental real estate, DSTs, REITs, and triple net leased properties. By understanding the unique benefits and tradeoffs of each, investors can identify which strategy best aligns with their risk tolerance, desire for cash flow, and need for liquidity or active management when evaluating 1031 investment options.