Tax-Deferral Real Estate Strategies

Written By Gerald F. Baker, III

The 1031 Exchange

Section 1031 of the Internal Revenue Code provides an effective strategy to defer capital gains tax through the exchange of real property for like-kind real property, which includes business/investment real estate, but not a primary residence.

The Delaware Statutory Trust

A Delaware statutory trust (DST) is a legal entity that allows multiple investors to pool their money to own and earn income from real estate properties, managed by a trustee, while offering potential tax benefits like deferring capital gains through a 1031 exchange.

Maximizing Tax Deferral

  • Find like-kind properties for reinvestment and adhere to proper 1031 exchange timeline

  • Use a Qualified Intermediary (QI) to manage proceeds

  • Buy enough replacement property to defer all capital gains

  • Leverage cash earned from sale and buy more valuable property

  • Build wealth by trading up for higher-value properties

The 721 Exchange

Section 721 of the Internal Revenue Code provides an alternative tax-deferral strategy to Section 1031 for property owners who are interested in selling real estate assets and wish to find an alternative to owning direct real estate. A Section 721 exchange allows investors to contribute ownership in real property to an operating partnership of a REIT in exchange for limited partnership interests in the operating partnership.

Potential Benefits of 721 Exchange via DST

  • Diversification - Access to an existing and growing portfolio of professionally managed, institutional-quality real estate diversified by asset classes and geography.

  • Income - An operating partnership that intends to provide regular income through an actively managed portfolio of income producing properties. Distributions are not guaranteed and there is no guarantee that objectives will be met.

  • Capital Appreciation - Holders of limited partnership interests may experience appreciation of their invested capital if the value of the real properties in the portfolio rises.

  • Tax & Estate Planning - Heirs to limited partners may receive a step-up in the tax basis of their limited partnership interests, effectively eliminating the previously deferred U.S. Federal Income Tax on Capital Gains. Heirs have the flexibility to make individual decisions in respect to the sale of their inherited interests, whereas traditional heirs of investment property may require collective decision making.

  • Flexibility & Self-Directed Liquidity - The redemption program for limited partnership interests may provide more liquidity than other forms of real property ownership and allows owners to redeem interests in whole or in part, potentially managing periodic taxable gain recognition in alignment with specific financial goals and objectives.

Important Distinctions between 1031 and 721 Exchanges

  • 721 exchange allows for greater portfolio diversification in terms of dollar value (portfolio of properties vs. one property)

  • 1031 exchanges offer investors liquidity at the end of each DST cycle, whereas 721 exchanges have limited liquidity through redemption, with each redemption being a taxable event

  • Executing a 721 exchange prevents subsequent 1031 exchanges

Content courtesy of Inland.

Gerald F. Baker, III

After working in various institutional investment firms, Jerry Baker founded Baker 1031 Funds, an investment firm dedicated to providing individual real estate investors with tailored 1031 exchange solutions. Baker 1031 Funds was established with the mission of offering individual investors the same opportunities as institutional investors, enabling them to enjoy the benefits large institutions typically have—without compromising what matters most to the individual investor.

Before founding Baker 1031 Funds, Jerry held key positions in the real estate private equity and hedge fund sectors. He served in various roles, including as a member of the investment committee, portfolio manager, and trading desk director. Over the course of his career, Jerry has been involved in more than $10 billion in commercial real estate transactions.

Much of Jerry’s real estate and investment expertise stems from his time spent working alongside his father and uncle in the family business. Whether underwriting potential acquisitions with his father or assisting his uncle with property maintenance, Jerry developed a hands-on understanding of real estate investing. These experiences not only equipped him with valuable skills but also gave him insight into the advantages institutional investors hold over individual investors, as well as a deep appreciation for the goals and challenges individual investors face.

Jerry is dedicated to supporting children's organizations in Detroit, Los Angeles, and New York. He is also an active contributor to the Babson College Alumni Association, focusing on student finance and real estate initiatives.

https://baker1031funds.com
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