How Can 1031 Exchange Investors Invest Passively in Syndications?

One of the most common questions real estate sponsors are asking today is whether they can accept 1031 exchange capital into their syndications.

With many investors selling appreciated properties and looking to defer taxes while stepping away from active management, the demand for passive 1031 investment options continues to grow. The challenge is that IRS rules prohibit investors from exchanging directly into a partnership interest, which creates significant hurdles for both sponsors and investors.

In this episode, Nate Sosa and Thomas Castelli break down three of the most common structures used to bridge the gap between 1031 exchanges and syndication investments: Tenants in Common (TICs), Delaware Statutory Trusts (DSTs), and 721 Exchange/UPREIT structures.

Why 1031 Exchange Money Is Difficult to Bring Into a Syndication

The core issue is simple: a 1031 exchange requires an investor to exchange real property for real property.

When an investor contributes capital to a syndication, they’re typically receiving a partnership interest—not direct ownership of real estate. Since partnership interests do not qualify as like-kind property under Section 1031, sponsors must use alternative structures if they want to accommodate exchange investors.

This often results in additional legal, tax, accounting, and operational complexity that many sponsors aren’t willing to undertake unless the investment amount is substantial.

Option #1: Tenants in Common (TIC) Structures

A TIC structure allows a 1031 investor to acquire a direct ownership interest in real estate rather than a partnership interest.

In a typical syndication scenario, the TIC investor owns a direct fractional interest in the property alongside the syndication entity. This allows the investor to satisfy 1031 exchange requirements while still participating in a larger real estate investment.

Challenges of TIC Structures

While TICs can work, they introduce several complications:

• Additional legal and accounting complexity
• Restrictions on sponsor compensation
• Ongoing compliance requirements
• Increased administrative burden
• Potential governance issues when major decisions need investor approval

Because of these challenges, many sponsors only consider TIC investors when the exchange amount is large enough to justify the added complexity.

Option #2: Delaware Statutory Trusts (DSTs)

DSTs have become one of the most popular passive 1031 exchange solutions available today.

In a DST, investors own beneficial interests in a trust that directly owns the underlying real estate. The IRS has specifically approved DSTs as qualifying replacement property for 1031 exchanges.

DSTs are often used for stabilized assets such as:

• Class A multifamily properties
• Industrial assets
• Net lease investments
• Large commercial properties with long-term tenants

The “Seven Deadly Sins” of DSTs

DSTs come with strict operational restrictions, including:

• No new capital contributions after closing
• No capital calls
• No new loans
• No loan renegotiations
• No major capital improvements
• No reinvestment of sale proceeds
• Limited ability to change tenants or renegotiate leases

These restrictions are designed to preserve the trust’s qualification for 1031 treatment but can significantly limit operational flexibility.

Option #3: 721 Exchanges and UPREIT Structures

A 721 exchange allows property owners to contribute appreciated real estate into a partnership in exchange for partnership units.

Unlike a 1031 exchange, investors are not receiving direct ownership in replacement property. Instead, they’re exchanging their real estate for an ownership interest in a larger investment vehicle.

Many larger real estate investment trusts (REITs) utilize UPREIT structures, where investors receive operating partnership (OP) units that can eventually be converted into REIT shares.

When 721 Exchanges Make Sense

These structures are commonly used when investors:

• Want to transition from active management to passive ownership
• Need estate planning flexibility
• Desire diversification across multiple properties
• Are comfortable with a long-term investment strategy

The downside is that once investors enter these structures, exiting can be difficult without triggering taxable gains.

The Bottom Line

There are several ways to accommodate 1031 exchange investors in real estate syndications, but none of them are simple.

TICs offer flexibility but create administrative complexity. DSTs provide a well-established passive investment option but come with significant operational restrictions. UPREIT and 721 exchange structures can work for larger operators but typically require substantial planning and infrastructure.

For both sponsors and investors, the right solution depends on deal size, long-term goals, and tolerance for complexity. Before pursuing any of these strategies, it’s critical to work with experienced tax, legal, and syndication advisors who understand the nuances involved.

Schedule a discovery call today.