What Financial Planners Need to Know About 1031 Exchanges

financial planners and 1031 exchanges

Most taxpayers like to involve their financial planners when doing a 1031 exchange. While it's a good idea to do this, many financial planners are not experts at executing 1031 exchanges. Here are a few things that financial planners need to know about 1031 exchanges.

Delaware Statutory Trusts

Many financial planners sell securitized investments set up as Delaware Statutory Trusts. These trusts have properties in them and they are subject to preexisting institutional (typically non-recourse) debt. So every owner that goes into that trust will put in their equity but will also be allocated a corresponding amount of that institutional debt.

When you’re sizing up how much replacement property your client needs to satisfy their 1031 you need to look at the specifics of each of those Delaware Statutory Trusts and make sure that the amount of their Value, Equity and Debt in the replacement property is sufficient.

A 1031 Example

Let’s say we have a client who sold a property for $100,000 but had an $80,000 mortgage against their old relinquished property. They need to buy a replacement property of roughly equal or greater value and equity. They also need to offset their debt relief of $80,000. If you put them into a replacement property that’s a Delaware Statutory Trust that has a lower ratio of leverage such as a loan to value of 50/50, then their $20,000 of net proceeds combined with 50% debt to equity won’t qualify as enough replacement property. You either need to find another trust to put them into, or they can fix the problem by putting more cash in (which would in turn increase their proportionate amount of dent allocated to their purchase).

The moral of the story is to put the relinquished property transaction under the magnifying glass. Analyze the equity and debt of your client, and make sure the size, value, and debt components of the new replacement property cover that of the relinquished property.

For more information on this topic, see our blog on the Napkin Test.

  • 1031 Hotline: If you have questions about what financial planners need to know about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.


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