If you’ve been researching the 1031 exchange as an option for selling investment property, you may have come across some new terminology. For example, many investors are unfamiliar with the term “accredited investor,” and they wonder how it relates to a 1031 exchange transaction. This discussion will explain the important details you need to know.
What is an Accredited Investor?
The Securities and Exchange Commission (SEC) defined the term accredited investor under Rule 501 of Regulation D, which is part of the Securities Act of 1933. It refers to an individual or entity deemed “financially sophisticated” and has a “reduced need for the protection provided by regulatory disclosure filings.”
Due to the advanced financial experience accredited investors likely have, it’s assumed they can understand complex investment vehicles. An investor who qualifies for this designation has access to certain investment opportunities not available to the broad general public.
Accredited Investor Requirements
It’s a common misconception that there’s a process you need to follow to become an accredited investor. However, this is not the case. To qualify, you’ll simply need to meet the following requirements:
- Earn an income of over $200,000 in each of the two most recent years (or $300,000 for married couples) and have a reasonable expectation of earning at least this much in the current year.
- Have an individual net worth or joint net worth with your spouse of over $1 million at the time of the purchase (excluding your primary residence)
There are also separate accredited investor provisions under Rule 501 for charitable organizations, corporations, partnerships, trusts, financial institutions, equity owners, and company directors.
Irrevocable Trusts
Investment properties that are titled under an Irrevocable Trust have a more stringent set of requirements. In general, Irrevocable Trusts can be an accredited investor if:
- The trust has a minimum of $5 million in assets or
- The trustee or co-trustee of the trust is a bank, insurance company, registered investment company, business development company, or small business investment company
For investors who wish to invest in options restricted to accredited investors from funds in an Irrevocable Trust having less than $5 million in assets, we recommend that they consider adding a trustee or co-trustee from one of the institutions listed above.
Do You Need to be an Accredited Investor to Do a 1031 Exchange?
A 1031 exchange is a process that allows real estate investors to defer their capital gains taxes by exchanging a piece of property for one or more “like-kind” properties. Any investor can engage in a 1031 exchange without worrying about qualifying as an accredited investor.
However, if you are planning on exchanging your property and using a Delaware Statutory Trust (DST) for your replacement property (which meets like-kind property requirements of the 1031 exchange), then the accredited investor requirement kicks in.
The SEC categorizes DSTs as “securitized investments,” triggering the accredited investor requirement. Like other unregistered investments, DSTs can often be complex investments and are considered illiquid, making them inappropriate for inexperienced investors.
The bottom line is that you do not have to be an accredited investor to engage in a 1031 property exchange, but you do if you plan to exchange your property for ownership in a DST.
Learn More About 1031 Exchanges
While it’s not necessarily difficult to engage in a 1031 exchange, there are many moving parts. Therefore, it’s often helpful to consult with a professional before starting, as this may help you avoid costly mistakes.
To learn more about the 1031 exchange process and whether it might be right for you, reach out to our team. We’re happy to discuss your goals and help you explore your options.
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