The Real Estate Loophole for Investors
Do you ever wonder how major real estate developers like Donald Trump get away with paying little to no income taxes? Their secret is something called the 1031 Exchange.
This is just one tax loophole they use. There is another tax loophole called the 721 Exchange which allows real estate developers to save even more money on their taxes. The real estate publication, Real Estate Weekly, refers to this as the “best-kept secret” of the real estate industry.
The 721 Exchange and 1031 Exchange are similar because they both allow your capital gains tax to be deferred. However, the 1031 Exchange requires you to take your profits and invest them into a “like-kind” property. The 721 Exchange, on the other hand, lets you invest the profits into a real estate portfolio, otherwise known as a Real Estate Investment Trust. This allows you to diversify your investment by purchasing ownership in multiple properties rather than just one.
If you wanted to invest $300,000 in real estate, you could choose to invest in just one property with a very limited deadline, or you could invest in 8 or 12 mega real estate investment funds. The latter gives you direct ownership to several properties and earns you a 15%+ return each year. The best part is that you don’t need to manage the properties. It’s kind of like owning stock in the properties rather than in a company.
The properties of these portfolios often consist of high rises, huge apartment complexes, office buildings, and other real estate developments.
Is 721 Better Than 1031?
The 1031 Exchange has its perks, but there are some downsides to it. After you sell your property, you need to purchase a new property quickly because the deadline to do so comes fast. If you’re trying to negotiate with a seller, then you might feel tempted to make a bad deal for yourself because of the deadline that you need to meet.
A bad deal usually means you overpay for the property, either on the sales price and/or the taxes. The property may require repair work too.
Get High Returns with Diversification
Investment funds give you so many advantages that 1031 Exchange’s do not. There are no strict deadlines or pressure to make a quick deal, which means you can purchase whenever you want.
Previously, accredited investors (or affluent investors) had exclusive access to invest in private equity funds. To become an accredited investor, you needed at least a $1 million net worth (not counting your primary home). Either that or your annual income over the last 2 years had to be $200,000.
So basically, the people with a lot of money go the exclusive right to make a lot more money with their investments. Fortunately, there are more opportunities now for investors with a smaller net worth.
Real Estate Securities and Crowdfunding
Let’s look at how the market functions and the way in which the 721 Exchange could benefit you here.
New industries are disrupting the traditional marketplace. For example, a lot of people think cryptocurrency is the currency of the future, while others think it is destined for failure. As for crowdfunding, this is beneficial to the average person who wants to raise money for some project or cause.
Now the real estate industry has crowdfunding going on in it too. Fundrise is the main place to go to invest in real estate offerings. When Fundrise first started out, they sold ownership of the World Trade Center to regular investors for only $5,000. The company basically made a deal with Larry Silverstein to purchase his bonds for $5 million. Once they did that, they resold the bonds to all the regular investors.
This captured national headlines and brought a lot of major players to the marketplace.
The Jobs Act: Title III
Up until this point, only accredited investors could take advantage or crowdfunding offerings. This all changed on November 16th, 2015, after the U.S. Congress and the Securities Exchange Commission gave their approval to a section of the Jobs Act called Title III. This section allowed non-accredited investors to partake in crowdfunding offerings.
How to Invest in Deals
The crowdfunding marketplace has seen a lot of successful startup companies, such as Crowdstreet and Arborcrowd. There are lots of opportunities for the 721 Exchange here. Shares can be sold to average investors as well as bigtime real estate investors, funds, and developers.
If you’re eligible for the 721 Exchange, this is a huge hack. You can make a deal with real estate developers, landlords, and other operators. They can give you access to much better real estate deals, either a portfolio of properties or a single property.