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Our ApproachWhat is a 1031 Exchange?
In a technical sense, a “1031 Exchange” is a shorthand reference to an exchange of real property executed in accordance with 26 U.S.C. § 1031 of the U.S. Code (“Code”). Section 1031 of the Code provides that an exchange of “real property held for productive use in a trade or business or for investment if such real property is exchanged solely for real property of like kind which is to be held either for productive use in a trade or business or for investment” is a nontaxable exchange. See 26 U.S.C. § 1031(a)(1). As a nontaxable exchange, no gain or loss is recognized. Id.
In more simple terms, a 1031 Exchange allows the owner of real property to sell their real property (the “Relinquished Property”) and acquire a similar (or “like kind”) piece of real property (“Replacement Property”) without having to pay taxes on the gain from the sale of the original property.
(Overly)Basic Example
Alan acquired Greenacre (a piece of real property) for $1,000,000 for investment purposes. Three years later, Alan sold Greenacre for $1,500,000. All things being equal (and ignoring the possibility that Alan depreciated or made improvements to Greenacre), Alan’s gain would be $500,000 which would be subject to taxation. Assuming the applicable long term capital gains tax rate in this scenario was 20%, this would mean that Alan would net $400,000 in profit after taxes upon the sale of Greenacre.
However, Alan is a shrewd investor, so instead of selling Greenacre and harvesting the gain, Alan instead executes a 1031 Exchange by selling Greenacre and acquiring Blueacre (another piece of real estate) for $1,500,000. By executing the 1031 Exchange, Alan does not recognize the $500,000 in taxable gain and therefore avoids paying the 20% long term capital gains tax.
Tax Deferred Versus Tax Free
Successful 1031 Exchanges simply defer the taxable gain from the sale of the Relinquished Property; they do NOT eliminate the tax burden altogether (a common misconception). This means that when the Exchanger sells the Replacement Property, the Exchanger will be required to pay tax on both the gain created from the Replacement Property and the deferred gain from the Relinquished Property (unless of course the Exchanger executes another 1031 Exchange in which the Replacement Property itself becomes Relinquished Property).
Revisiting the (Overly)Basic Example
Two years after successfully completing the 1031 Exchange of Greenacre for Blueacre, Alan sells Blueacre for $2,000,000. If Alan does not execute a 1031 Exchange, then Alan’s taxable gain from the sale of Blueacre is $1,000,000 ($500,000 from Blueacre plus the $500,000 in deferred gain from Greenacre). Again, assuming the same 20% long term capital gains tax rate, Alan nets $800,000 in profit upon the sale of Blueacre.
Importance of “Like Kind” Exchange
Section 1031 of the Code makes clear that to qualify as Replacement Property the property must be “like kind” to the Relinquished Property. This is a critical component of the 1031 Exchange Process. In a technical sense, the IRS considers whether property is of a like kind by looking to “the nature or character of the property and not to its grade or quality. One kind or class of property may not, under that section, be exchanged for property of a different kind or class. The fact that any real estate involved is improved or unimproved is not material, for that fact relates only to the grade or quality of the property and not to its kind or class.” See 26 C.F.R. § 1.1031(a)-1(b).
The definition of “like kind” has been the subject of significant litigation, IRS rulings and regulatory clarifications, which we will not discuss here. However, in a very general sense, the exchange of one piece of real estate for another piece of real estate (regardless of the difference in location, quality, asset type, etc.) qualifies as “like kind”. However, and importantly for many investors, exchanging a piece of real estate for a security does NOT qualify as “like kind”.
Revisiting the (Overly)Basic Example, Again
In connection with Alan’s sale of Blueacre, Alan wants to execute yet another 1031 Exchange. However, Alan no longer wants to actively manage real estate and wants to take a more passive investment position. Alan learns about RedCo LLC (a Delaware LLC), who is acquiring Redacre (another piece of real property) for $10,000,000. Alan is interested in investing in RedCo’s acquisition of Redacre and wants to invest using the exchange proceeds from the sale of Blueacre. Therefore, what Alan is effectively trying to do is exchange Blueacre (a piece of real property) for limited liability company membership interests (a security). However, even though RedCo itself will acquire a piece of real property (which is like kind to Blueacre), this type of exchange fails the 1031 Exchange requirements because the “Replacement Property” is not like kind.
How Hanson Capital Solves the Dilemma
At Hanson Capital, we’ve successfully facilitated 1031 Exchanges for numerous investors. This isn’t a hypothetical structure or a one-time workaround—it’s a proven and repeatable approach we’ve implemented multiple times with precision.
Our 1031 Exchange structure is built around direct ownership through a Tenants-in-Common (TIC) arrangement. This means the 1031 investor (the “Exchanger”) takes a direct ownership interest in the real estate alongside our investment fund. Ownership is split pro-rata based on each party’s capital contribution. For example, if the Exchanger brings $2 million and our fund contributes $3 million, the Exchanger would own 40% of the asset, while the fund holds the remaining 60%.
To ensure legal and tax compliance, our legal team works with the investor to establish a Special Purpose Entity (Exchange SPE), wholly owned by the Exchanger. This subsidiary becomes the actual party executing the 1031 Exchange, which is crucial in isolating the transaction from any other assets or liabilities the investor may hold.
While the Exchanger retains ownership, day-to-day management responsibilities are handled by our general partner entity, which acts as the Manager of the Exchange SPE. In return, the Exchanger agrees to pay the same management and performance fees as any limited partner in our fund—ensuring fair and consistent treatment.
Final Thoughts: A Smarter Path for 1031 Exchanges
Navigating a 1031 Exchange can be complex—especially when trying to balance the desire for passive income with the strict “like kind” requirements of the IRS. Too often, investors find themselves stuck between wanting to diversify or simplify their portfolios and the limitations of the tax code.
That’s where Hanson Capital Industrial Funds delivers a clear solution. Our well-structured, 1031 Exchange approach gives investors direct ownership in real property, offers access to institutional-grade assets, and aligns management incentives through transparent, proven terms. Whether you’re seeking to defer taxes, reduce operational headaches, or co-invest in high-quality industrial real estate, we’ve built a process that works—again and again.
Ready to explore your 1031 Exchange options with a partner who’s done it before? Visit www.hansonre.com to learn more or get in touch with our team. Let’s turn your real estate gains into long-term growth—without the tax burden.
