What Is a 1031 Syndication and How Does It Work?

A 1031 syndication is a strategy for real estate investors to defer capital gains taxes by pooling their funds with other investors. This allows them to acquire a fractional interest in a larger replacement property as part of a tax-deferred exchange under Section 1031 of the Internal Revenue Code. The structure facilitates a 1031 exchange for individuals who may not have the time or resources to find and manage a suitable property on their own. For investors seeking passive income and portfolio diversification without direct management duties, this approach is appealing as it provides access to institutional-grade properties that would be beyond their financial reach as a sole owner.

Understanding the Structure of a 1031 Syndication

The most prevalent legal structure for a 1031 syndication is the Delaware Statutory Trust (DST). A DST is a separate legal entity that holds title to one or more real estate properties, and investors purchase a beneficial interest in the trust itself, not the real estate directly. This fractional ownership structure allows the investment to qualify as “like-kind” property for a 1031 exchange. The Internal Revenue Service (IRS) sanctioned the use of DSTs for 1031 exchanges in Revenue Ruling 2004-86. This guidance clarified that a beneficial interest in a qualifying DST is considered a direct interest in real estate for tax deferral, and a trustee appointed by the syndication sponsor is responsible for all management decisions, so the individual investor has no management responsibilities.

An alternative structure is the Tenant-in-Common (TIC) arrangement, which provides each investor with a direct, deeded interest in the property. Unlike a DST, each co-owner’s name is on the property’s title as they own an undivided fractional share of the real estate. The distinction from a DST is governance and control. IRS Revenue Procedure 2002-22 outlines the guidelines for TIC arrangements to qualify for a 1031 exchange, requiring that major decisions like selling or refinancing be approved by the co-owners. This gives investors more direct say in operations compared to a DST, but it also introduces more complexity in management.

Information and Decisions Prior to Investing

Before investing in a 1031 syndication, an investor must engage a Qualified Intermediary (QI). The QI is an independent third party whose role is to hold the proceeds from the sale of the investor’s original property. To comply with Treasury Regulations, an investor cannot have actual or constructive receipt of the sale funds, making the use of a QI mandatory before the initial property sale closes.

Thorough evaluation of the syndication sponsor and the specific investment offering is necessary. This due diligence involves researching the sponsor’s history, track record, and expertise in the target market. Investors should analyze the fee structure, which includes upfront acquisition fees, ongoing asset management fees, and a profit-sharing arrangement upon sale. All of this information is detailed in the Private Placement Memorandum (PPM), a legal document that discloses the investment’s objectives, risks, and terms.

Investors must provide information to the sponsor to verify their eligibility. This includes providing documentation to prove they meet the Securities and Exchange Commission (SEC) definition of an “accredited investor.” This status is verified by confirming an individual’s net worth exceeds $1 million (excluding their primary residence) or their annual income meets certain thresholds. The investor will also need to supply personal identification and details about the legal entity making the investment, if applicable.

The Investment Process Step-by-Step

Once an investor has sold their original property and the proceeds are held by the Qualified Intermediary (QI), the 1031 exchange timeline begins. The first deadline is the 45-day identification period. Within this window, the investor must formally identify potential replacement properties, such as beneficial interests in one or more DSTs, by delivering a signed, written designation to their QI.

After identifying the DST interest, the investor executes the subscription documents provided by the syndication sponsor. This packet includes the subscription agreement, which is the legal contract to purchase the interest in the DST. By signing, the investor formally commits to the investment and attests to their accredited investor status and understanding of the risks outlined in the PPM.

With the subscription agreement signed, the investor provides a signed directive to their QI, instructing them to wire the exchange funds to the syndicator’s closing account. This transfer of funds must be completed within the 180-day exchange period allowed under Section 1031 rules.

Upon completion of the transaction, the investor will receive a closing statement and confirmation of purchase from the sponsor. This documentation serves as the official record of their beneficial ownership in the DST and is needed to finalize the reporting of the 1031 exchange on their tax return.

Post-Investment and Exit Scenarios

After the 1031 exchange is complete, the investor enters the holding period. During this time, the investor receives periodic income distributions, which are paid out monthly or quarterly. These payments represent the investor’s pro-rata share of the net rental income after all operating expenses and management fees have been paid.

For tax reporting, the syndicator provides an annual statement that outlines the investor’s share of the property’s income, deductions, and credits. Since these investments are structured as a Delaware Statutory Trust (DST), investors receive a “grantor letter” or a “substitute 1099” rather than a Schedule K-1. Using this letter, the investor reports their rental income and expenses on Schedule E of their tax return. The statement also details depreciation, a non-cash expense that can offset the taxable portion of the income distributions.

When the sponsor sells the underlying property, the investor faces two primary outcomes. The first option is to receive their share of the net proceeds, at which point the previously deferred capital gains taxes become due. The second option is to roll the proceeds into a new 1031 exchange, often into another syndicated DST offering, allowing for the continued deferral of the tax liability.