In a 1031 Exchange, the replacement property must be “like-kind” to the relinquished property. The difference in type, grade and quality does not matter. Generally, any real estate held for business or investment purposes in the U.S. or U.S. Virgin Islands is considered “like-kind”. For example, a landowner can exchange a commercial property for another, or a residential rental property for a commercial property, and vice versa.
Active vs. Passive: While there are almost an infinite amount of choices for replacement property, the most basic place to start is active versus passive ownership.Active: Active ownership is as it sounds; the property owner manages the property and any issues that arise from that property. Property owners looking for active ownership typically buy nearby properties for ease of oversight. In doing this, they often sacrifice asset type diversification and are beholden to the tax regulations of that state. Another challenge active owners often encounter is the ability to find quality properties at desired prices within the timeframes allowed under the 1031 Exchange guidelines. Typical Active Properties: Farm/Ranch land, raw land, rental houses, apartments, small office buildings, self-storage properties, etc.
Passive: In our experience, we’ve found most people are selling their property in an effort to simplify their lives. As such, a passive ownership structure seems to suit them the best. A passive ownership structure is one where the property owner is “hands-off”. There are no weekend calls to fix water leaks or furnace issues. These structures have a management team in place to handle daily operations, maintenance issues and financial management. These typically provide a stress-free income stream for the property owners. For passive owners, the quality, history and track record of the management company is more important than geographical location. This allows for excellent diversification and potentially tax-advantaged income streams by buying properties with more favorable state income tax regulations. Typical Passive Properties: DST’s, UPREIT’s, etc.