How to 1031 Exchange into Real Estate Syndications 2023

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Real estate syndications have exploded in popularity among investors seeking passive income, diversification, and higher yields than many traditional investments offer. But if you’re a landlord looking to switch to passive syndication investing, can you avoid capital gains taxes by 1031 exchanging your existing rental property into a real estate syndication deal?

The short answer is yes — but it’s harder than you think.

What Is a 1031 Exchange?

Named after Section 1031 of the tax code, a 1031 exchange is a tax deferring strategy used by real estate investors to sell a property and reinvesting the profits to purchase another property. There are a few stipulations, of course. The new property you purchase must be of “like-kind,” meaning a similar property of similar value to the original one sold.

So where does the tax deferment come in? Well, because you’re using your profits to buy a new property, you can delay paying capital gains tax until the new property is sold.

Let’s look at a more concrete example. Larry is finally ready to unload one of his rental properties that he’s tired of dealing with. But he knows when he sells, he’ll get hit with a hefty tax bill, and that’s the last thing he wants. He’s been thinking about purchasing another property anyway, so a 1031 exchange just makes sense.

If Larry expected to make a $200,000 profit on the sale of his rental, rather than dealing with capital gains tax, the 1031 exchange allows Larry to direct that $200,000 towards purchasing his next investment property.

How Does it Work?

Remember, this is a simplified explanation. The 1031 exchange process is actually quite complex, which is why it is important to work with a qualified intermediary such as a real estate attorney, CPA, or title company. This person facilitates the exchange and is responsible for holding the proceeds from the sale of the original property until the new property is purchased.

In general, here’s how a 1031 exchange works:

Before investing in a replacement property, the investor enters into an agreement with a qualified intermediary, who holds the property titled in their name as a neutral third party.
The investor then sells their current investment property and the qualified intermediary puts the funds into a dual account.
The intermediary then holds the title of the replacement property in their name until the investor sells it, thus preventing the investor from having to pay capital gains taxes on the transaction.
The investor then identifies one or more potential replacement properties within 45 days of selling the original property.
The investor then signs an exchange agreement (which details the timeline and specifics of the exchange) with the qualified intermediary and must close the deal on the replacement property within 180 days of the sale of the original property.
Once the investor closes on the replacement property, the investor will now own the new property, and the transaction is complete.

Can You Invest Into a Syndication With a 1031 Exchange?

Yes, you can invest in a syndication with a 1031 exchange, if you follow a specific protocol. The bad news? You have to invest a lot of money.

Before we get too far ahead of ourselves, what is a real estate syndication? A real estate syndication is a private real estate deal where multiple passive investors (known as limited partners or LPs) pool their money with a lead investor (also called the sponsor or general partner). Together, they use the pooled money to buy larger (and theoretically more profitable) commercial real estate holdings such as apartment complexes, self-storage units, or office buildings.

Now, back to the actual exchange. To 1031 exchange property profits into a syndication deal, you must invest by becoming a joint owner in the syndication under “tenants in common” (TIC) ownership. A TIC structure is simply the legal form of property ownership between two or more parties. With a syndication, you and the syndicator enter into a TIC arrangement that gives you each an ownership share of the property.

This creates far more paperwork for the sponsor however. As a result, most sponsors only agree to a TIC ownership structure if you invest a hefty sum, typically half a million or a million dollars (or more).

Without the TIC ownership structure, the IRS considers your syndication shares to be securities rather than property. Remember, a 1031 exchange necessitates a like-kind exchange and real property cannot be exchanged for securities, so you can’t use a 1031 exchange to buy standard shares in a syndication.

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How to 1031 Exchange into Real Estate Syndications

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What Is a 1031 Exchange?

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