1031 Crowdfunding Review
1031 Crowdfunding is a Reg D crowdfunding platform specializing in an esoteric corner of real restate investing known as “1031 exchanges”. “1031” refers to IRS Code section 1031, which allows taxpayers to defer paying capital gains taxes on the sale of certain kinds of real estate if they use the proceeds to buy other real estate investment properties.
- Website: https://www.1031crowdfunding.com
- Investment Types: Real Estate
- Sectors: Commercial Real Estate
- Minimum Investment: $25000
- Advertised Returns: 5-7%
- Must be accredited
- Excellent tax advantages
- Wide selection
- In-depth diligence materials provided
- High minimums
- Open only to accredited investors
- Uses complex legal structure (Delaware Statutory Trust)
1031 Crowdfunding simplifies the process of swapping ownership (partial or full) from one (or more) properties into one (or more) new properties, thereby deferring paying capital gains taxes. Investors who don’t currently own any properties can also invest, presumably in advance of future 1031 exchanges of those investments.
The investment vehicle is also a tad esoteric, known as a Delaware Statuatory Trust (DST) which differs from the LLC model of most crowdfunding sites. This is probably not the place for a novice real estate investor. Not only is the minimum investment on the high end at $25,000, but navigating DSTs and 1031 exchanges will almost certainly require assistance from a CPA and/or an attorney. That said, 1031 Crowdfunding does a great job making a complex topic approachable.
Types of investments 1031 Crowdfunding offers
The platform solely offers investments in real estate, specifically real estate being exchanged through 1031 exchanges rather than sold. Sales are taxable, whereas exchanges are not.
The way an exchange works is that a property owner or an investor chooses to acquire a replacement property in a short time period after selling their existing property. If you simply sell your original property, capital gains taxes on any gains over $250,000 for a single person or $500,000 for a married couple on a primary home can be in excess of 30% when both state and federal taxes are taken into account, and the amount can be even more for a property that does not serve as an owner’s primary residence. If you decide to exchange the value of your original property for the value of a new property, rather than cashing out, you are not subject to the capital gains tax on a home sale.
In order for an exchange to qualify as like-kind, it must meet the IRS criteria of being one of two types of property: (1) property held for investment or (2) property held for productive use in a trade or business. However, you do not need to perform a one-to-one swap or exchange for a transaction to qualify. According to the IRS rules, you could sell three different properties each equal to one-third the value of the property you then purchase, and this counts as an exchange. So does selling one high-value property and purchasing two or three smaller ones, so long as they are of the same “like” kind.
1031 Crowdfunding is only open to accredited investors.
What do you get when investing with 1031 Crowdfunding?
When you decide to invest with 1031 Crowdfunding, you are purchasing a beneficial interest in a DST. The DST holds equity in various real estate properties, and performs the exchanges. One of the difficulties ordinary investors face in completing like-kind exchanges is the time requirement. There is a 45-day period after selling the original property in which you must identify a replacement property and notify the seller or the seller’s agent (not just your own agent or attorney). You then have either 180 days or until the end of the tax year to complete the purchase of the replacement property. 1031 Crowdfunding removes some of the anxiety inherent in having to adhere to these deadlines by doing the required notifications and making sure purchases are completed in the appropriate amount of time.
The IRS allows either cash investors or 1031 exchange investors to participate in this kind of investment. Cash investors are any investors who decide to invest through a DST. 1031 Crowdfunding allows these investors to become 1031 exchange investors through their platform and use of a DST:
Once the real estate that is in the DST is sold, it will allow the cash investor to start the 1031 exchange process allowing for the deferral of taxes in any future real estate transactions. For the 1031 exchange investor the DST must comply with the requirements of IRS Revenue Ruling 2004-86 so that beneficial interest in the trust is treated as a direct interest in the real estate for tax purposes so they are 1031 exchange complaint upon sale of the property
How does 1031 Crowdfunding make money?
The fees charged by 1031 Crowdfunding are fairly typical for a DST, but much higher than the fees charged by other crowdfunding platforms. In addition, there is a higher bar to entry because of the higher minimum investment amount of $25,000.
- Acquisition fee: 3.5%
- Disposition fee: 3.5%
- Financing fee: 1%
- Property management fee: 4% of gross rent
- Refinancing fee: 1%
Potential returns and cashflow
Investing in a 1031 exchange is typically a longer-term proposition than other crowdfunding investments, whether in real estate or other areas. The holding period for the debt on many deals available through the 1031 Crowdfunding platform is 7 to 10 years, although some are as low as 5-7 years. With respect to returns:
DSTs are permitted to keep a reasonable amount of cash reserves to be prepared in the event the property requires repairs or faces unexpected expenses. However, all earnings and proceeds above the reserve amounts must be distributed to the beneficiaries on a regular basis and within the expected timeframe.
A closer look at the sample deals on 1031 Crowdfunding shows a forecasted cash flow of 5 to 7% on average.
Breadth of offerings on 1031 Crowdfunding
More than 25 investments are typically available, all in real estate. But there is a wide variety available, ranging from student housing, to multifamily homes, to retail space and medical and law offices, and there is a special selection of investments in Senior Housing. The loan-to-value ratio (LTV) is lower on most offerings than on many comparable investments, with the majority in the range of 40 to 65%, and many offerings are on debt-free properties.
Regulatory framework and due diligence expectations
1031 Crowdfunding markets investments under Reg D section 506(b) and (c). This means that, in addition to being open only to accredited investors, the platform has to require investors to actually prove their accreditation before they can view the details of many deals. For this reason, if a layperson logs onto the platform website, most of the deals are not visible unless you create a profile that includes proof of your accreditation. Along with and perhaps in part due to these stricter rules, 1031 Crowdfunding offers more complete and upfront due diligence on various offerings than many comparable platforms. For example, some offerings provide an audited track record of the sponsor or an attorney’s opinion on the legality of a given 1031 exchange. These are usually tough for potential investors to access. While you still need to do your own due diligence it is a perk.
You may be able to invest in 1031 Crowdfunding using a Self-Directed IRA or 401K. To learn more about using a Self-Directed retirement account for alternative investments, visit our friends at Rocket Dollar.
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