Fractional Ownership and 1031 Exchanges: Accessing Real Estate
Investors seeking access to high-quality, income-producing properties without taking on the full cost of ownership are increasingly exploring fractional ownership structures. For real estate investors using a 1031 Exchange, understanding how fractional ownership fits within IRS rules is essential.
This guide explains how fractional ownership works, how it relates to 1031 Exchange eligibility, and what investors should know before participating.
What Is Fractional Ownership in Real Estate?
Fractional ownership allows multiple investors to purchase shares or interests in a single property. Each investor owns a percentage of the property and typically receives a proportional share of the income, expenses, and potential appreciation.
This model gives investors access to larger or higher-quality properties—such as commercial buildings, multifamily complexes, or medical offices—that might otherwise be out of reach for individual buyers.
Common structures for fractional ownership include:
Tenancy-in-Common (TIC): Each investor owns a separate, undivided interest in the property.
Delaware Statutory Trust (DST): Investors own beneficial interests in a trust that holds title to the property.
While both allow multiple owners to share in real estate investment, they differ significantly in structure and IRS treatment.
How Fractional Ownership Can Work with a 1031 Exchange
Under IRS rules, 1031 Exchanges allow investors to defer capital gains taxes by selling one investment property and reinvesting the proceeds into another like-kind property held for investment or business use.
The key question is whether a fractional interest qualifies as like-kind real estate for exchange purposes.
Tenancy-in-Common (TIC) Interests
A TIC interest can qualify for a 1031 Exchange if it meets IRS requirements. Each owner holds a deeded real property interest, meaning they directly own a share of the underlying real estate.
The IRS issued Revenue Procedure 2002-22, which outlines the conditions under which TIC ownership is considered valid for 1031 purposes—such as limiting the number of co-owners and requiring separate ownership rights and voting control.
Delaware Statutory Trust (DST) Interests
A DST is a more passive structure where investors purchase beneficial interests in a trust that owns real estate.
In Revenue Ruling 2004-86, the IRS confirmed that DST interests qualify as like-kind real property for 1031 Exchange purposes, as long as the trust is structured according to specific rules.
Because of their simplicity and limited management responsibilities, DSTs have become a popular option for investors looking to complete turnkey 1031 Exchanges—particularly those seeking passive income after selling actively managed properties.
Benefits of Fractional Ownership for 1031 Investors
Fractional ownership can provide several advantages for investors completing a 1031 Exchange:
Access to institutional-quality real estate that would otherwise require millions in capital.
Diversification across multiple property types, locations, or tenants.
Passive income opportunities through professionally managed assets.
Easier identification and closing within the IRS’s 45-day and 180-day timelines.
These benefits make fractional ownership—particularly through DSTs—a compelling strategy for investors transitioning from direct ownership into more hands-off investments.
Key Considerations and Risks
Despite its advantages, fractional ownership requires careful evaluation. Investors should be aware of:
Limited control: Especially in DSTs, management decisions are made by the trustee or sponsor.
Liquidity constraints: Selling a fractional interest may be difficult before the property’s disposition.
Sponsor risk: Performance depends on the experience and integrity of the sponsor or manager.
Compliance requirements: Not all fractional arrangements meet IRS like-kind standards.
It’s important to work closely with a Qualified Intermediary, CPA, and legal advisor to ensure the investment structure aligns with 1031 Exchange regulations.
What This Means for 1031 Investors
For those seeking access to larger or more diversified real estate opportunities, fractional ownership can be an effective 1031 Exchange strategy. It allows investors to maintain tax advantages while shifting toward more passive investments—just make sure the structure complies with IRS requirements and fits your long-term goals.
