Shared Top Border
sdcia_head3.jpg (14795 bytes)
SDCIA Message Board
Sign up Latest Topics

  Author   Comment  

Senior Member
Posts: 2,275
Reply with quote  #1 
I have someone who wanted information about these alternatives to a 1031 exchange.  Has anyone actually tried these?  The advantage is that they are passive management and it doesn't require the investor to manage yet another property.  I asked a 1031 company out of the Bay Area whether they knew anyone who was happy with these type of investments.  Given that returns on investment properties are very low these days (2% or 3% in many cases) he indicated that the 5 to 6% returns are alot better deal.

But if you read the private placement memorandums (you might need a lawyer to do that) the disclaimers are frequently breathtaking, including:
1. The entire investment could lost.
2. The investment will typically be tied up for 3 to  7 years.
3. The managers of the fund are not your fiduciaries and are not required to act in your best interests.
4. The liquidity of the shares may not be there.
5. The manager may not be required to supply audited financial statements during the time of management.
6. The manager will decide when to sell.
7. If you exit the investment before the term, you may only receive the amount of your original investment, even assuming you can find someone to buy it.
8. The Class A and B properties these funds typically buy are favored by REITs so that the prices paid are through the roof.
9. It's hard to diversify a portfolio since I don't know anything that isn't seriously overpriced right now.  Some asset classes like office and retail are positively scary.  Multifamily has appreciated and alot of investors consider it the safest.  But it has already appreciated so much--how much higher can it go?   Warehouse and other specialized type of industrial properties move in sync with the economy and that has been appreciated (sometimes slowly) for a very very long time---much longer than the average cycle.

Alot of these investments appear to be Class A or B commercial properties.  Many of the funds tout the fact that these leases involve national credit tenants.  But to me these kind of assurances strike me as empty.  Most national credit tenants have very favorable leases that allow them to cancel without any penalty or notice.  That is why so many of the Sears, Penneys, KMart, etc can simply close stores without filing bankruptcy.  Starbucks?  I hear that they have defaulted on alot of their NNN leases because they overbuilt.  Also, given the advent of Amazon, retail in particular is arguably overbuilt---store closures have become common, not at all unusual.   If what alot of these investments are doing is safeguarding the portfolios against these type of risks of major commercial landlords, it might be riskier than it appears at first glance.

There is very little in the way of balanced presentations about these products out there.  Back in 2005 when the TIC investment fever was in full swing, I was very skeptical since the investor loses so much control.  Alof of these investments, it turned out, were what I would call roach motel type investments---there was no liquidity.  So investors check in, they do NOT check out.

But I was hoping that the industry might have improved and evolved.

One of the more negative videos that I found out there is a series of videos by an investor whose videos aren't professional, just the guy (unidentified), very amateur in term of production values, and his video camera.  Also, we know nothing about this guy or his background or what happened with the investments he made.  Althugh, he's obviously a disgruntled investor.

But he makes some good points.  (Here is his rant about all the fees)

Has anyone actually done this?

Sometimes you are just better off paying the taxes.  Otherwise, if and when the RE market finally does crash, you won't have any money to play with.  I think this is the conclusion Rick Solis arrived at---and which is probably closer to my own thinking right now.  But if  you have been investing for quite a while, the tax bill might seem scary.  So, no easy choices.

Senior Member
Posts: 2,063
Reply with quote  #2 
A friend of mine from San Diego did three TICs around the 2005 time period after selling two of his commercial buildings. One turned out very good (CA.), and two were major disasters – Texas and Florida. I don't remember the specifics, but I do recall one eventually had some very ugly tax consequences.

There was a period around 2012-2013 when we'd be on the golf course and his round would be ruined by a call from one of the co-owners. He said there was total chaos and disagreement among the co-owners and a nightmare for him. Numerous times he said, "I would have been so much better facing the initial tax liability."

I believe there's a good amount of marketing expenses packed into TIC deals. His were sold to him by a securities broker. I guess TICs are one of those deals where a lot of people get their beaks wet along the way.

Senior Member
Posts: 2,275
Reply with quote  #3 
Thanks, Paul.

It's interesting because your response shows one further problem----you end up being partners with a bunch of strangers and if things end up badly, finding a solution may not be easy---because any response would (arguably) require all of your partners to agree.

I don't know whether your friend had a DST, a TIC or something else.  But if it was a DST, then common disadvantages include a lack of liquidity, the investor has no control, if the fund needs to do major capital improvements this can easily eat up several years of profits, and the DST better have adequate reserves because it is illegal for them to raise new capital---they need to get it from existing investors.

This is maybe what happened to your friend.

Also, given the large # of investors if things go wrong there are going to be (in most cases) too many investors to get to agree to a common strategy.  Thus, a REIT, for example, is required by the IRS to have a minimum of 100 investors---but it may include many, many more--like thousands.  So some of the features required by the IRS for a REIT include:

  Invest at least 75 percent of its total assets in real estate
  • Derive at least 75 percent of its gross income from rents from real property, interest on mortgages financing real property or from sales of real estate
  • Pay at least 90 percent of its taxable income in the form of shareholder dividends each year
  • Be an entity that is taxable as a corporation
  • Be managed by a board of directors or trustees
  • Have a minimum of 100 shareholders
  • Have no more than 50 percent of its shares held by five or fewer individuals
By contrast, TIC investments are required to be limited to no more than 35 investors.

 And the other problem in the scenario you mentioned---even if he had 2 deals that worked out OK and one deal that was a catastrophe---the catastrophic deal can put everything at risk.

The other approach is to find a larger property that has sufficient income to include a margin for management--maybe a higher class multifamily.  But the problem is that at this point you are probably competing with REITs---so be prepared to pay top dollar.  The other problem is that properties like that aren't exactly easy to find---but it is one possible option.

I am now thinking that paying your taxes---maybe you do it gradually by selling one property per year to lessen the tax hit---arguably is a better solution.  Certainly, I would do that instead of investing in these DSTs or other alternatives mentioned---even if you (maybe) might get away from real estate property management headaches---though your friend traded those in for other headaches.

The problematic part is that, if you have 20 to 30 years worth of transactions, then paying taxes gets somewhat complicated.

But here is the way I look at it---you are selling for inflated prices right now anyway---and you can use the extra money for taxes.  (Even if you have to end up paying approximately 1/3 or more (depending your situation)---it's still probably worth it.

My impression is that alot of buyers got taken advantage of in the 2005/2006 time frame using this option---and that is why I have never taken it seriously.   Some of these options might be legitimate, but given that they all use the same kind of broad disclaimers, I'm not sure how one is supposed to choose.  But it also seems true that if you make the wrong choice, there is no remedy for it.

As I recall, back in the heady days of 2006, I remember a speaker basically saying that only stupid investors paid taxes as opposed to doing a 1031 exchange.  

But I also recall Rick Solis saying that alot of the investors he knew ended up losing all their money.  And the real problem is that anything you buy in a superheated market is going to be overpriced anyway---so you have a margin there for paying your taxes.  What I have always liked about Rick Solis is that he is very honest about having made mistakes---he doesn't try to sell the reader on the notion that all of his transactions went according to plan.

The truth is that if you keep doing 1031 exchanges you start to feel like a rat on an everlasting treadmill--and you find fewer and fewer deals that actually make sense.  Better to have a smart accountant with a long term strategy of tax saving and harvesting equity over the long haul.

Actually, the best tax stategy is to die while doing 1031 exchanges---your heirs receive it at a stepped up basis and all the capital gains and depreciation recapture goes away.  But what is the point of earning the money if you never can enjoy it?


Senior Member
Posts: 2,275
Reply with quote  #4 
There is also a difference in terms of these entities in regards to possible exit strategies.

One can't 1031 out of an upreit transaction----once the property is sold, you can't 1031 into anything else.

According to Exeter 1031

Risks Associated With A 1031 Exchange Into An UPREIT

Investors who 1031 Exchange into an upREIT have exchanged into a security and therefore no longer own real estate.  Since the investor now owns a security, he or she cannot 1031 Exchange out of the upREIT and into other real estate.  The sale or disposition of their interest in an upREIT will result in a taxable transaction, including the recognition of their deferred capital gain and any depreciation recapture. 

The upREIT also has control over the asset they 1031 Exchanged into and therefore has control over  the sale or disposition of the asset.  The sale or disposition of the asset can trigger the recognition of the investors deferred capital gain and any depreciation recapture.  Some upREIT sponsors will guarantee that they will not trigger any taxable gain for a specified number of  years, while others remain silent regarding the potential for triggering the deferred taxable gain.

I don't know what this is based upon, but one company states that with a DST a further 1031 is possible:

Upon the sale of a property in a DST, the investor will have the option to pay any capital gains tax or defer any capital gains tax by participating in a 1031 exchange.

A TIC investment permits further 1031 investments as well:

Upon liquidation of the investment, the TIC investor can take her cash and pay the taxes, trade into a new property as a sole owner, or roll the investment into another TIC investment. Finally, some TIC agreements permit an investor to convey her investment to an insider or a third party under certain terms and conditions.

Accordingly, I don't think much of the upreit option since it requires you to pay taxes eventually anyway.  I'm not sure how anyone else views the situation, but I find this disadvantage critical.

Actually, the story may be more complicated since a partnership interest in real property might qualify.  

According to one website:
What are the benefits and drawbacks of UPREITs? The principal benefit of the UPREIT structure is that it enhances a REIT’s ability to acquire properties by allowing non‐corporate holders of low tax‐basis real estate to participate in property/OP Unit exchanges on a tax‐deferred basis.    That is, a transfer of real property (or interests in a partnership owning real property) to an OP solely in exchange for OP Units may qualify as a tax‐deferred transaction under Code Section 721.    In contrast, a transfer of real properties directly to the REIT in exchange for REIT shares would ordinarily be fully taxable.  The IRS has recognized the validity of the tax deferral for a properly designed UPREIT structure.

I think what Exeter says above is still correct, BTW----if you are, in effect, trading a real estate ownership interest for a security then you will have to pay taxes.  But the above passage assumes you have something different than an ordinary real estate ownership interest.)

There is also a difference in terms of control, whereas REITs and DSTs provide the investor with little control, in a TIC type investment the investor has voting rights.

My own feeling is that I wouldn't rule out the possibility of investing in a TIC type investment since there is some measure of control and the # of investors is at least limited---though I would have to implicitly trust the organizers and managers, not to mention believe that the investment was a really good one.

The features of most TIC type investments (including their voting rights) were established by the IRS in a 2002 Revenue Ruling.

Also, whether TIC investments are liquid is a factual matter, but at least the TIC rules entitle the TIC investment owner to alienate their interests without unreasonable restraints----the lender may require some alienation restrictions and the TIC agreement might provide a right of first refusal to other TIC members---but at least alienation of interests isn't prohibited.

I don't want to overstimate the extent of control the typical TIC investor may have over their own investment, especially since there is room for clever lawyerly drafting, but at least I wouldn't consider the whole idea of a TIC investment foreclosed as a matter of principle.  Since majority voting is possible under a TIC and you at least have certain rights from the outset, still I think you would have to read the documents to really know to what extent the investor is given any meaningful vote or control.

In my view, Section 1031 is arguably overhyped since the far better avenue is Section 121 since under that section you get to keep the gain within the limits of 250/500K.  (But this exclusion doesn't apply to 2nd homes, in fact, there aren't many options to avoid paying taxes when disposing of a 2nd home).

Actually, one of the features upreits is that you can't 1031 out of an upreit which may be a consideration if you want to stay involved in real estate in terms of future acquisitions.  So, you might wake up one morning, the property  sells and you owe alot of taxes.  I spoke to one 1031 company and they said the only investors they knew who did upreits were over 80 years old and didn't really have a long term perspective on things.

A TIC (which also has fewer members) is arguably a better choice---and more popular these days.


Senior Member
Posts: 2,275
Reply with quote  #5 
Alright, so what about a monetized installment sale pursuant to IRC Section 453?

"Do your clients want to sell their rental or investment property only to find out that TAXES will eat up all their profits, OR better yet, have to come out of pocket just to sell it?

Are you tired of managing your property and want to cash in but don't want to do a 1031 exchange?

Have you reviewed other tax strategies and don't want to give up control of your income or assets?

Are you real estate rich but cash poor?

If you answered yes, you might want to consider at Monetized Installment Contract.

In 2012 the Chief Counsel of the IRS issued a Memorandum concerning the use of an Installment Sale (IRS code C453), coupled with a monetized loan. It is now possible to defer the tax on the sale of highly appreciated Real Estate for as long as 30 years and receive as much as 95% of the selling price in cash. "

This is the way the transaction was described:

So, with this strategy, a third-party financial institution can lend you a non-taxable amount equal to 95% of the sale price (93.5% after loan-related costs). You can re-invest those proceeds or spend them however you like.

At the end of the installment period, the Dealer will pay you the agreed selling price that will provide you the money to repay the loan, and you’ll pay the tax with significantly discounted dollars. The strategy even offers significant estate-tax advantages!

• Seller transfers the asset to Dealer in exchange for lump sum payment of the purchase price payable in 30 years.

• Dealer simultaneously transfers asset to Buyer in exchange for agreed-upon price.

• Third-party Lender extends nontaxable cash equal to 93.5% of sale amount to Seller.

• After 30 years, Dealer pays the agreed sale price, Seller uses that money to repay the loan, and Seller pays tax with discounted dollars."

I don't really know enough about this scenario to make any kind of judgement.

But these strategies can be used together in same transaction (50% IRC sale and 50% 1031 exchange)


Senior Member
Posts: 2,063
Reply with quote  #6 
Thanks for posting that Larry. I didn't know about the Monetized Installment Contract. I Googled around and tried to find an example with numbers but wasn't successful.

Senior Member
Posts: 2,275
Reply with quote  #7 

Well, Paul, I would issue a caveat: As you know when I post on subjects it is usually an effort to understand a field so I am no expert.   In particular, I'm not a tax lawyer, not an estate planner, not an asset protection attorney  or related fields.

I would call Exeter 1031 and ask them about it.  If they consider it a complicated matter, you might get a call from Bill Exeter himself.

And not all of the alternatives were ones that I posted on.

A case in point: there is a group (seems to be only a handful of organizations) that uses an entity that they call "deferred sales trust".  

Here is the website of the organization that I seem to find most frequently cited.

So why didn't I cite them as an alternative?  Because I went onto a website I trust mainly used by  practicing attorneys that attacks scams and questionable practices and they seemed very skeptical about it.

This is a somewhat complicated answer, but there used to be an entity called a private annuity trust.  Here is the wikipedia entry about it.

The IRS outlawed this entity in 2006, although they did grandfather those members of the public who used it.  And alot of attorneys on that website felt this "deferred sales trust" was very similar to that outlawed entity.  Actually, this private annuity trust even though it was ultimately outlawed was (apparently) a really great entity---I wish I had participated in it while it was still legal.

It was also (apparently) mentioned by advocates of this new entity said that they had a private letter ruling from the IRS, but that it was confidential.  That's a real problem because when the IRS issues a PLR it is NOT confidential or private----and their inability to cite any ruling that supports this new entity looked very problematic.

Also, there is alot of money  to be had when investors 1031 all their earnings over the decades---and quite frankly I am surprised that there aren't more websites about it---though maybe that is just because I haven't found them yet.

If you go on their website you will also notice the "tm"---which means that they claim to have trademarked the use of this term.  But since average attorneys can't really figure out what this new entity means---and its legality---I didn't include it in the above summary.

The other thing that is suspicious about the deferred sales trust is that this organization licenses individuals to promote it and gives them fees for doing so---so it is not just this organization that is touting their product.

Having said that, however, I would ultimately rely on the advice of Bill Exeter about the Deferred Sales Trust and I don't know what he thinks about this approach at this point.  Update: Exeter doesn't recommend Deferred Sales Trust because he considers it risky.  He won't go into detail, but he has scrubbed his entire website from having any reference to it.  Enough said.

Also, with regard to the "monetized installment contract" I probably should have mentioned that I don't really know alot about this approach.  The reason that I found this especially interesting was that one way to avoid the hassles of property management is to carry paper on a property.  But that isn't a 1031 strategy---though these guys claim to be able to make that strategy work.  I believe there are strategies under IRC 453, but I really don't understand all of the complexities---and I am still trying to learn more about them.  In the video mentioned below, Bill Exeter basically says that installment sales can defer capital gains, though it would be a poor choice for a property that has alot of depreciation recapture.  (You recapture 25% of the depreciation when you sell---and can be taxed on it).  

As I say, the guy who I consider a genius about 1031 exchanges is named Bill Exeter----I learned about him like a couple decades ago when an attorney from a large firm in downtown Los Angeles mentioned that when commercial investors have complicated exchanges they make a beeline to his firm.  So, unless someone like him signs off on it---I wouldn't necessarily take it at face value.  And although I am going to one of his talks, it won't be until the end of october.  But I will try to ask him about this (and other complexities).
It is possible that both of these strategies are 100% legitimate---but I would do further research before arriving at that conclusion.

It 's a shame someone like Ward doesn't have a course on 1031 type alternatives---though it isn't listed in the courses on his website.  

Anyway, here is a short video where Bill Exeter explains some of the basic statutory approaches to tax exchange.


Senior Member
Posts: 2,275
Reply with quote  #8 
I tend to believe that the best strategy is either doing (1) 1031 exchanges or (2) paying taxes bit by bit each year.

Unfortunately, due to the 3.8% Medicare tax passed in 2010, you would get penalized if you made to large a distribution in any one tax year.  (See below).

What I am particularly impressed is the generosity of the 121 deduction and the way that you can combine 121 with 1031 in the sale of your home.  Thus, it only requires that you live in your house 2 out of the last 5 years for the 250/500 deduction.  but if you rent it out for the remainder you can also 1031 out of the sale of your house any excess above the 250/500 deduction. 

Here are 3 different scenarios in terms of the use of these tax provisions:

Finally, this is an explanation of how the Medicare tax works:

How the new health care tax works

Avatar / Picture

Senior Member
Posts: 1,013
Reply with quote  #9 
My three step process:
1) Just pay the taxes
2) Spend the money
3) Have Fun!
You can't take it with you.

Previous Topic | Next Topic

Quick Navigation:

Easily create a Forum Website with Website Toolbox.