A real estate investment trust, or “REIT” for short, is a commonly used corporate structure for holding large portfolios of investment properties. REITs receive special tax treatment due to the fact they are required to pay 90% of their taxable income as dividends to shareholders and 75% of the gross income must come from the REIT’s property holdings.
1031 Real Estate Investment Trust (REIT) In Detail
REITs vary in size significantly and can own portfolios of institutional quality properties worth hundreds of millions to many billions of dollars. Some of the advantages of investing in REITs can include diversification, professional management, transparent financial records (in many cases REITs publish audited financials annually), and potential liquidity. Frequently, REITs are listed and traded on stock exchanges, but there are other REITs which are private or non-traded.
Due to the large amount of properties which a typical REIT owns, investors can benefit from stable income generated by rents coming in each month from the underlying assets. Diversification can come from the properties being located in multiple parts of the country (or world in the case of Global REITs), having multiple tenants, and from owning various types of investment properties (i.e. offices, warehouses, apartments, etc.).
Although a REIT is not considered “like-kind” by the IRS for 1031 exchange purposes, an investor who owns an asset which a REIT wants to acquire can execute a 721 exchange (also known as an “UpREIT” transaction). Section 721 of the Internal Revenue Code allows an investor to defer capital gains taxes and depreciation recapture when trading their property to a REIT in exchange for operating partnership units, which are then directly exchanged for shares of the REIT. However, it is not common for large REITs to make small, single-asset acquisitions, so your potential to perform a Section 721 Exchange may be very limited depending on what size and quality of real estate you own.
A more likely scenario for an investor is to sell an investment property, 1031 exchange into a larger, more institutional asset or portfolio of assets structured as a Tenants-In-Common (TIC) or Delaware Statutory Trust (DST). Then upon disposition of its assets, the TIC or DST can sell to a REIT and offer the original investors an ability to exchange their interests for operating shares of the REIT at that time via a 721 Exchange.