1031 Exchange in Syndications

A 1031 exchange is a major tax benefit associated with real estate ownership, which allows the deferral of capital gains by exchanging the gain into a like-kind property upon sale rather than receiving all the sale proceeds in taxable cash. Combining a 1031 exchange with a sponsored investment allows a 1031 exchange investor to essentially become a limited partner investor in a professionally managed investment vehicle. The investor performing the 1031 exchange into the venture can also 1031 exchange out their interest upon sale. This is advantageous since typical limited partners in a real estate investment are unable to 1031 exchange their individual ownership interest upon sale and must rely on a deal-level 1031 exchange if they wish to defer capital gains taxes upon sale. The reason for this is because limited partners technically do not own real estate. Instead, they own a partnership interest in a real estate venture which is ineligible for a 1031 exchange, since 1031 exchanges must be like-kind exchanges of real property.

1031 exchanges in joint ventures or syndications are structured using a tenancy in common structure, which allows the 1031 investor to take direct title to the property, which is one of the key requirements of a legitimate 1031 exchange. A complication of the TIC structure within a management partnership is that the "tenants" in common have joint and several ownerships of the property with equal control. However, in a syndication/joint venture, the sponsor is supposed to have decision making control (this is important for the lender as well since they are lending based on the sponsor’s control and ability to oversee the success of the deal). Typical joint venture economics and control rights can be outlined through a side-letter or through other means to make the 1031 fit into a traditional syndication/joint venture structure.

Not all sponsors offer their investors the opportunity to 1031 exchange, so it is a great way for Lone Star Capital to stand out because we have developed the expertise and put in the extra effort to structure deals this way. To learn more about 1031 exchanges in syndications, watch my recent webinar on the topic here: 1031 Exchange Webinar on YouTube.

Our team has experience structuring 1031 exchanges in our investments both with agency lenders, bridge debt, and banks. The greatest source of complexity comes from the lender requirements when it comes to the TIC structure, especially Fannie Mae and Freddie Mac. Because the 1031 TIC investor is a direct owner of the property, they are technically a borrower in the eyes of the lender and therefore must be underwritten. Being underwritten by a lender includes a credit check, background check, disclosure of personal financial statement, schedule of real estate owned, and business resume. This does not mean the 1031 investor has to be a guarantor on the loan, but sometimes lenders ask for limited guarantees. We handle this entire process for our 1031 exchange investors as well as form and manage the single purpose entity which is the vehicle holding title on behalf of the 1031 investor as required by the lender. To learn more about investing a 1031 exchange with us, please reply to this email.