FWR delves into the details of what are called 1031 exchanges, structures dating back about 100 years, and structures that are closely associated with these, called Delaware Statutory Trusts. Handled in the right way, these are valuable parts of the wealth toolkit, but some advisors fret about a lack of industry expertise.
When taxes take a sizeable bite from capital gains in real
estate, it is easy to see why a structure dating back a century –
the 1031 exchange – is creating more of a buzz when HNW
individuals fret about tax bills when property is sold.
There are opportunities for smart investors and advisors.
However, there are also risks for not understanding the fine
print, advisors warn. When real estate assets often comprise a
high chunk of a person’s total net wealth, mistakes are costly.
(Capital gains taxes do not affect a person”s principal
residence.)
A 1031 exchange lets investors defer capital gains tax on the
sale of one investment property by reinvesting the proceeds into
a like-kind property. To qualify, the relinquished and
replacement properties must be held for investment or business
purposes. There’s a time limit: Replacement property must be
identified within 45 days, and the exchange must be completed
within 180 days.
An estimated $8.6 trillion in equity is held in investment
properties by households aged 55 and older and typically moves
via the 1031 route.
As an example of what is happening, earlier in June, Centre
Street Partners, an investment firm focusing on lower
middle-market buyouts, announced the launch of its real estate
transaction services platform, Accretus. It launched with the
acquisition of Atlanta Deferred Exchange, an Atlanta-based
Qualified Intermediary that facilitates 1031 exchanges for
property owners and investors.
Another case: in March, Fortress
Investment Group ($54 billion AuM at end-September 2025) said
it had launched Fortress Real Estate Exchange, a new 1031
exchange platform that gives advisors and their clients access to
“institutional quality real estate investments” through Delaware
Statutory Trusts (DSTs). A DST is a distinct legal entity used
for real estate investment, allowing multiple investors to hold
fractional, passive ownership in large, institutional-grade
properties. DSTs are commonly used in 1031 exchanges.
Advocates of DSTs, which have existed since 2004, say
they are robust and proven to be so during the political
cycle. A DST is open to accredited investors. Individual
accreditation requires $200,000 or more of annual income
($300,000 joint), $1 million-plus in net worth (excluding
primary
residence), or qualifying professional licenses.
Why 1031 exchanges are gaining attention
A lot of Baby Boomers, who have second homes, for example, fear
that they if they sell them, it will trigger a tax bill, David
Hammerman, chief operating officer for global real estate at
Fortress, told Family Wealth Report in a recent
interview. This explains why the 1031 exchange route is becoming
more of a talking point.
1031 exchanges have been around for more than a century, so are
unlikely to be significantly changed by legislators, he said,
“They are very tried and tested.”
As for DSTs, the “market is going to be one of the key sources of
capital raising in real estate,” he said. Importantly, Hammerman
said, DSTs are fixed investment trusts and units are not meant to
be sold or redeemed ahead of a structure being
unwinded.
“This isn’t a concern in the market and is rather a feature of
the product. Investors going into a traditional DST want as
long a duration of a product as possible, so they do not
have to deal with another 1031 exchange,” he said.
“We view DSTs as a significant market opportunity. One key reason
why Fortress is excited about entering the DST market is that the
space remains in the early stages of institutionalization
– particularly within the traditional DST market, wherein
sponsors are not primarily focused on a forced 721a UPREIT
transaction as the exit strategy,” Hammerman said.
(An UPREIT, or “Umbrella Partnership Real Estate Investment
Trust,” is a type of property acquisition transaction, where a
property owner contributes his/her property to a Real Estate
Investment Trust (REIT) in exchange for ownership in the REIT. It
is also referred to as a “Section 721 Exchange” – like a
1031 Exchange because it can allow property owners to defer
capital gains on appreciated real estate.)
“With institutionalization, we believe investors will
increasingly demand greater transparency, more rigorous
underwriting, due diligence and asset management. Market
participants have shared their desire for DSTs as part of client
portfolios, but that there is frustration with the industry
around reporting transparency,” Hammerman said.
Sufficient expertise?
Drew Reynolds, CIO at Realized, says the 1031 exchange route has
its value, but he is concerned whether the RIA sector has the
advisory infrastructure and expertise to handle capital of this
size and complexity. Realized says it helps investors evaluate
and design diversified DST portfolios using data and analysis so
they can make informed decisions.
“With advisors coming into the space, do they know what they’re
doing?” he told FWR in a call. “There is an asymmetry in
the transaction on the investor side. The average size of a 1031
exchange is $1.3 million of equity and $1.2 million on the
property value side. This is often the single largest asset
investors own – up to 30 or 40 per cent of their net worth.”
Instead of a more diversified asset allocation process, the
process is akin to exit planning, Reynolds said. “This is a very
significant decision with long-term implications that may
represent different things for different people.”
“It [real estate] is placed into alternative allocations by
default because it is [deemed] private real estate,” he
said.
Another challenge, Reynolds said, is that advisors will typically
have encountered the 1031 property issue only once or twice a
year and won’t necessarily have the experience and expertise to
make the right calls.
Reynolds wrote in a LinkedIn post in May: “Take it out of
the context of real estate for a moment. A client comes to you
with an exit planning event representing 40 per cent of their net
worth. Concentrated capital. Severe tax consequences – can
approach 40 per cent of the gain. Technical and regulatory
nuance. A compressed, non-negotiable timeline. For this client,
it may be the single most important financial decision of their
life.
“What would you do? You’d deploy every resource you
have: Exit planning team. Tax counsel. Full menu analysis.
Documented decision-making at every step. Ongoing monitoring
through every transition that follows. That’s a 1031 exchange,”
he wrote.
Wagging the dog, and acting in a rush
There is a risk that the use of exchanges and related structures
to mitigate tax bills carries costs that users might not
initially appreciate. There are, to coin a phrase, no free
lunches in capitalism.
“The 1031 exchange is one of the most powerful tools in real
estate, but the danger is letting the tax tail wag the investment
dog,” Jason Milton, CEO and co-founder of Custom Capital, who
has a background in large real estate deals, told FWR.
“A bad asset doesn’t become a good asset just because you 1031’d
into it. The 45-day identification window tends to push people
into rushed acquisitions and weaker assets just to avoid a tax
bill, and deferring into an inferior property isn’t a win!”
There are several issues that registered investment advisors must
understand, he said.
First, a qualified intermediary holds the client’s proceeds and
it is important to choose the correct one. Milton said that
intermediaries have “failed or misused funds, which loses money
and blows the exchange at the same time. The IRS rarely issues
extensions for missing the 45-day or 180-day windows, so vet the
qualified intermediary closely,” he said.
Secondly, DSTs are “marketed as turnkey 1031 solutions but often
carry heavy upfront costs and are illiquid,” he said,
arguing that advisors and clients should consider a variety
of options before committing.
Thirdly, Milton said: “A good question to ask: `Would I buy this
if I wasn’t time restricted?’ In our opinion, a well-located
single-tenant net lease property with a strong tenant and a
long-term lease is one of the best homes there is for exchange
capital – but it requires diligent, consistent underwriting
to uncover properties like that.”
For all the cautionary words, there is no doubt that the sums
involved are large, and likely to get larger, particularly amidst
multi-trillion dollar wealth transfer where bricks-and-mortar
assets are a large part of the pie. Tax mitigation approaches
will always get a hearing in such an environment.
“The 1031/DST market is going to grow strongly in the next 20
years…the market can grow to $20 to $30 billion in DSTs, up from
about $9 billion today,” Hammerman added.
