Investment real estate is the largest asset class in the U.S. behind the equity and bond markets. Millions of investors allocate some portion of their investment portfolio to income properties, including commercial and multifamily real estate, to diversify their assets and as part of a potential wealth-building strategy.
Before you invest in real estate — or add to your portfolio if you already own investment property — you should know about two increasingly popular passive investment vehicles, and one of the most attractive real estate tax benefits.
Two Ways to Passively Invest in Real Estate
No. 1: Delaware Statutory Trusts
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
A Delaware Statutory Trust (DST) is an entity used to hold title to investments such as income-producing real estate. Most types of real estate can be owned in a DST, including industrial, multifamily, office and retail properties. Often, the properties are institutional quality similar to those owned by an insurance company or pension fund, such as a 500-unit Class A multifamily apartment community or a 50,000-square-foot industrial distribution facility subject to a 10- to 20-year lease with a Fortune 500 logistics and shipping company.
There can be up to 499 individual investors in a DST, typically. Each investor holds an undivided fractional interest in the property or properties (if the DST holds multiple assets), making the investor an owner. That said, decision-making authority typically rests with a trustee who is the asset manager designated by the sponsor of the DST offering. The asset manager takes care of the property day to day and handles all investor reporting and monthly distributions.
A DST is considered a security and is governed by securities laws. The typical minimum investment in a DST is $100,000. Owners of a DST receive an operating statement at the end of the year showing their pro-rata portion of property income and expenses, which investors input onto Schedule E of their tax return, in the same way that you would any other commercial or rental properties that you may own directly.
No. 2: Tenants-in-Common
A tenants-in-common (TIC) structure is another way to co-invest in real estate. With a TIC, the number of allowable investors is limited to 35. As a result of the lower investor limit, the minimum investment requirement to purchase a property through a TIC may be substantially higher than a DST. We often see minimums for TIC investments between $250,000 and $1 million.
Although TIC investments and DSTs have their nuances and differences, they often will hold title to the same types of property. While the DST is generally considered the more passive investment vehicle, there are some circumstances in which a TIC is desirable, including if the investors wish to utilize a cash-out refinance after owning the TIC investment for a few years in order to get some of their equity back, which can be invested in other assets.
Real Estate Tax Benefit that Helps Build Wealth
Whether you’re invested in DSTs or TICs, you are eligible to take advantage of one of the most attractive real estate tax benefits on the books in the U.S.: the 1031, or “like kind,” exchange.
1031 exchanges are so-called because they are governed by Section 1031 of the Internal Revenue Code. About one-third of all commercial and multifamily property sales involve a like-kind exchange, which is available to investors of all income levels. (You don’t have to be a high-net-worth investor to take advantage of this tax benefit.)
A like-kind exchange allows an investor to defer capital gains, depreciation recapture and other taxes at the time an investment property is sold if the net equity from the sale is reinvested into a property of the same or greater value. With a 1031 exchange, an apartment building can be exchanged for a warehouse, a warehouse for a medical office building, a medical office building for a drugstore, etc.
The net effect of 1031 exchange investing: The initial invested capital and the gain can continue to grow tax deferred if the asset gains value. With a 1031 exchange, no tax consequences are triggered after a property sale. Then, if and when the new investment is sold without the equity reinvested in another exchange property at some later date, the prior gain would be recognized.
Not all properties qualify as like-kind exchange replacement properties under the Internal Revenue Code. But DSTs and TICs do. A person can invest into a DST property to qualify for the tax treatment when they sell their investment property, or invest out of a DST into another DST or another property of like-kind (Internal Revenue Code Ruling 2004-86) to maintain the tax benefit.
If you already own real estate and are contemplating a sale, this could potentially be a great time to exchange into another property. Some national policymakers are considering changing the rules that govern 1031s. The tax benefit could work differently in the future.
-
6 Stunning Waterfront Homes for Sale Around the USFrom private peninsulas to lakes, bayous and beyond, Kiplinger's "Listed" series brings you another selection of dream homes for sale on the waterfront.
-
Six Reasons to Disinherit Someone and How to Do ItWhether you're navigating a second marriage, dealing with an estranged relative or leaving your assets to charity, there are reasons to disinherit someone. Here's how.
-
Should You Still Wait Until 70 to Claim Social Security?Delaying Social Security until age 70 will increase your benefits. But with shortages ahead, and talk of cuts, is there a case for claiming sooner?
-
Retirement Planning for Couples: How to Plan to Be So Happy TogetherPlanning for retirement as a couple is a team sport that takes open communication, thoughtful planning and a solid financial strategy.
-
Market Turmoil: What History Tells Us About Current VolatilityThis up-and-down uncertainty is nerve-racking, but a look back at previous downturns shows that the markets are resilient. Here's how to ride out the turmoil.
-
Home Insurance: How to Cut Costs Without Losing CoverageNatural disasters are causing home insurance premiums to soar, but don't risk dropping your coverage completely when there are ways to keep costs down.
-
Markets Roller Coaster: Resist the Urge to Make Big ChangesYou could do more harm than good if you react emotionally to volatility. Instead, consider tax-loss harvesting, Roth conversions and how to plan for next time.
-
Why Homeowners Insurance Has Gotten So Very ExpensiveThe home insurance industry is seeing more frequent and bigger claims because of weather, wildfires and other natural disasters.
-
Going Through Probate? How to Find the Right AttorneyJust having the skills and experience to do the job isn't enough. The probate attorney you hire needs to have the right temperament for your particular case.
-
Widow's Penalty: Three Ways to Protect Your FinancesHigher Medicare premiums, smaller Social Security payments, bigger tax bills … Financial changes can hit hard when a spouse dies. How to counter the blow.
