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Case Study
Active Working Couple Leverages
1031 Exchange and 121 Exclusion

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    This case study delves into the strategy of restructuring a real estate portfolio undertaken by Jack and Rose, a couple in their forties. Their objective was to enhance returns, minimize management responsibilities, and optimize tax efficiency. This analysis provides a detailed examination of their utilization of the Section 121 Exclusion in conjunction with a 1031 Exchange, a sophisticated strategy beneficial for owners of highly appreciated primary residences transitioning to investment properties.

    Case Study Snapshot

    Jack and Rose 1

    Meet Jack and Rose

    Due to a professional relocation from Southern California to Seattle, WA., Jack and Rose sold their rental properties by leveraging the Section 121 Exclusion and reinvested proceeds into Delaware Statutory Trusts (DSTs) via 1031 Exchange. 

    Background

    Jack and Rose, previously residing in Southern California, owned two single-family properties initially serving as primary residences before conversion to rental properties. With their family’s relocation to Seattle, Washington for professional reasons, they elected to sell these properties, prompted by the logistical challenges of remote property management.

    The substantial appreciation realized from these assets since their initial acquisition—particularly the first property acquired in 2014 and the second experiencing a $900K appreciation—presented an opportunity for tax-efficient reinvestment strategies.

    Opportunity and Challenge

    Faced with significant potential tax liabilities from the sale of their properties, the couple sought a strategy that permitted tax deferral and negated the need for active property management. Their objectives were comprehensive to:

    • Defer taxes and achieve passive income
    • Prioritize total returns with a focus on appreciation
    • Leverage substantial depreciation deductions to shield income
    • Ensure simplicity in tax compliance and flexibility for future exchanges
    • Convert future investments into personal use properties, like vacation homes

    Exchange Strategy

    Combining Section 121 Exclusion with 1031 Exchange

    Prompted by their accountant’s advice, Jack and Rose engaged with Real Estate Transition Solutions (RETS) to explore passive investment avenues and the potential to amalgamate the benefits of Section 121 Exclusion with a 1031 Exchange. The Section 121 Exclusion permits homeowners to exclude up to $500,000 of capital gains from the sale of a primary residence from taxable income, contingent on the homeowners having used the property as a primary residence for at least two out of the five years preceding the sale.

    This exclusion, applicable once every two years, was pertinent for their second rental property. Under the guidance of RETS, they resolved to sell both properties, applying the Section 121 Exclusion to the second property’s gains, and to reinvest the proceeds into Delaware Statutory Trusts (DSTs) via 1031 Exchanges.

    Single Family Rental #1 ... Qualified for 1031 Exchange

    Single Family Rental #2 ... Qualified for 121 Exclusion

    Investment Strategy and Portfolio Design

    The Real Estate Transition Solutions 1031 Exchange Advisor curated a DST portfolio aligned with their aspirations for appreciable returns, tax deferral maximization, and passive management. The portfolio composition was as follows:

    • 50% in senior housing property with zero debt, offering future exchange flexibility and a simplified investment approach
    • 30% in multifamily properties situated in states without income tax
    • 20% in student housing to exploit consistent demand and growth potential
    Jack and Rose Portfolio

    Outcome and Strategic Implementation

    This strategic realignment allowed for complete deferral of capital gains tax, meeting their goals for passive income, minimal management, and tax-efficient planning. The initial annual cash flow projection indicated a 4.5% yield, with depreciation shielding 45% of the income from taxes. Situated predominantly in non-income tax states, their portfolio is poised for significant appreciation. The 5-7 holding period offers flexibility for future exchanges into properties potentially convertible for personal use.

    Conclusion

    This case study underscores the critical role of professional advice from a CPA and Licensed 1031 Exchange Advisor in navigating the complexities of real estate investment taxation. Through strategic utilization of Section 121 Exclusion and 1031 Exchange, Jack and Rose crafted a tax-efficient, passive investment strategy that dovetails with their financial and lifestyle objectives, highlighting the value of meticulous planning and professional guidance in the realm of real estate investment.

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    Speak with a Licensed Exchange Advisor

    Navigating the complexities of 1031 Exchanges, DSTs, and UpREITs requires expert guidance. If you are an investment real estate owner with questions about 721 UpREIT Exchanges, DSTs, or estate planning, contact Real Estate Transition Solutions (RETS) to schedule a complimentary consultation with one of our licensed 1031 Exchange Advisors.

    One of the aspects that sets RETS apart is our rigorous approach to due diligence. This process involves a thorough analysis of financial performance, market conditions, and potential risks associated with each property. Our team of 1031 Exchange Advisors works closely with you to ensure that every investment aligns perfectly with your financial goals, providing expert guidance and detailed insights every step of the way. This careful, strategic approach to due diligence is fundamental in helping you make informed decisions, safeguarding your investments, and achieving successful outcomes.

    Our free consultations can be done over the phone, via web meeting, or in person at our offices located in Seattle, WA and throughout the West Coast. To schedule your free consultation, call 888-755-8595, email info@re-transition.com, or book directly with an Advisor online.

    About Real Estate Transition Solutions

    Real Estate Transition Solutions (RETS) is a consulting firm specializing in tax-deferred 1031 Exchange strategies and Delaware Statutory Trust investment property. For over 26 years, we have helped investment property owners perform successful 1031 Exchanges by developing and implementing well-planned, tax-efficient transition plans carefully designed to meet their objectives. Our team of licensed 1031 Exchange Advisors will guide you through the entire process, including help selecting and acquiring passive management replacement properties best suited to meet your objectives. To learn more about 1031 Exchanges and Real Estate Transition Solutions, visit re-transition.com or call us at 888-755-8595.

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    The information herein has been prepared for educational purposes only and does not constitute an offer to purchase or sell securitized real estate investments. Such offers are only made through the Sponsor’s Private Placement Memorandum (PPM) which is solely available to accredited investors and accredited entities. DST 1031 properties are only available to accredited investors (generally described as having a net worth of over $1 million dollars exclusive of primary residence) and accredited entities only.  If you are unsure if you are an accredited investor and/or an accredited entity, please verify with your CPA and Attorney.

    There are material risks associated with investing in DST properties and real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potentially adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal. Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated. Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk. Because investor situations and objectives vary this information is not intended to indicate suitability for any particular investor.  This material is not to be interpreted as tax or legal advice. Please speak with your own tax and legal advisors for advice/guidance regarding your particular situation.

    Securities offered through Aurora Securities, Inc. (ASI), member FINRA/SIPC. Advisory services through Secure Asset Management, LLC (SAM), a Registered Investment Advisor. ASI and SAM are affiliated companies. Real Estate Transition Solutions (RETS) is independent of ASI and SAM. To access Aurora Securities’ Form Customer Relationship Summary (CRS), please click HERE. For Secure Asset Management’s Form CRS, click HERE. Real Estate Transition Solutions, ASI, and SAM do not offer legal or tax advice. Please consult the appropriate professional regarding your individual circumstances.

    Client examples are hypothetical and for illustration purposes only. Individual results may vary.

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