Why Exchange Funds Hold Real Estate: The 20% Qualifying Asset Rule, Explained
Aaron White, CFP®
Head of Investor Solutions
How Cache uses institutional real estate to meet tax code requirements and support long-term stability
When people think about exchange funds, they usually focus on the headline benefit: diversifying a concentrated stock position without triggering taxes. But behind that benefit is a structural requirement that makes the entire system work: the qualifying asset.
It isn’t a marketing feature, and it isn’t optional. It’s a core part of the tax code.
Every exchange fund must hold at least 20% of its total assets in qualifying illiquid assets to preserve tax-deferred treatment when investors contribute appreciated stock. Most funds meet this requirement with real estate.
Here’s why the rule exists, how Cache meets it, and how today’s approach improves efficiency, diversification, and scale for both advisors and investors.
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Why Real Estate Is Required
Under Internal Revenue Code Section 721, an exchange fund must hold at least 20% of its total assets in qualifying assets, typically real estate or partnerships that own real estate. To meet this requirement, the fund must own the underlying asset—either directly or through a properly structured partnership.
Important: Publicly-traded REITs do not qualify for this rule. They may be attractive investments, but they do not meet the tax code structuring requirements for exchange funds.
What the Real Estate Allocation Looks Like
Cache invests its qualifying asset allocation through institutional private real estate partnerships benchmarked to the NCREIF ODCE Index, the institutional standard for core U.S. real estate.
These partnerships offer broad diversification, stable income from tenant cash flows, and professional management. Cache’s philosophy is to take only the amount of real estate exposure needed to support a non-taxable equity contribution or redemption.
The goal is simple: keep risks low, cover costs, provide stability, and let real estate be a modest tailwind over a full cycle.
The NCREIF ODCE Index
The ODCE Index tracks large institutional real estate portfolios owned by pensions, endowments, and foundations. These portfolios share three traits:
- Stabilized, income-producing properties
- Independent quarterly valuations and appraisals
- Diversification across major U.S. markets and property types
Historically, ODCE strategies have delivered roughly 6–7% annualized net returns, driven mostly by income. Think of ODCE as a real estate counterpart of indices you might be familiar with, like the Nasdaq-100 or the S&P 500.
In short: Cache’s real estate allocation mirrors the institutional core market: diversified, stable, and income-oriented.
Institutional Partners
Cache sources qualifying asset exposure through partnerships with LaSalle Investment Management and TA Realty, two of the most established real-estate managers in the United States. Cache continues to evaluate additional partners and has a strong pipeline of future options.
LaSalle Investment Management
Founded in 1980, manages $89B in global real estate
Fund Name: LaSalle Property Fund
TA Realty
Founded in 1982, manages $14B in U.S. real estate
Fund Name: TA Realty Core Property Fund
Portfolio Characteristics
Together, these managers provide access to hundreds of stabilized, income-generating properties:
- Industrial/logistics: 40–45%
- Multifamily: 30–40%
- Remaining mix: office, retail, medical office, life sciences
Each partnership is independently valued quarterly and audited.
In essence: Cache provides exposure to institutional-grade real estate: diversified, professionally managed, and built for consistency.
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The Evolution of Real Estate in Exchange Funds
Legacy Model
Older funds sourced real estate in-house by purchasing individual properties. This approach was compliant but had drawbacks:
- Forced-buyer dynamics near closing dates
- Concentrated exposure to a few buildings
- Slow onboarding (3–6 month cycles)
- Real estate supply bottlenecks
Modern Approach
Cache invests through established institutional real-estate funds instead of acquiring individual buildings.
Advantages:
- Broader diversification
- Professional oversight
- Continuous capacity
- Onboarding every two weeks
- Pricing at institutional NAV, not deadline-driven premiums
How Exchange Funds Finance the Real Estate Allocation
Every exchange fund uses a credit facility to finance its qualifying asset exposure. This keeps contributed stock fully invested and preserves tax deferral.
How it works:
- After each close, the fund borrows cash from a credit facility.
- The cash is invested in institutional real-estate partnerships.
- No contributed stock is sold.
- The fund remains fully invested and IRS-compliant.
Understanding the 20% Rule
Because the fund borrows to create exposure, the portfolio becomes:
- 100% equities
- +25% real estate (from borrowing)
- = Real estate represents 20% of total assets
Example: Investor contributes $1M in MSFT stock.
The fund borrows $250K and invests it in real estate.
Total portfolio = $1.25M → real estate is exactly 20%.
Important: After this point, equity and real-estate price movements do not affect compliance. No additional real estate is required due to market fluctuations.
Qualified Redemptions After Seven Years
After the required seven-year period, investors can redeem their fund interest and receive a diversified distribution of publicly traded securities (usually ETFs and stocks).
- Real estate remains inside the fund to support future investors. It is not distributed in redemptions.
- If real-estate exposure drifts above target, Cache uses quarterly redemption windows with its managers to rebalance.
This process keeps the fund stable, compliant, and tax-efficient.
Bringing It All Together
The real-estate component of an exchange fund is not a side investment. It is the foundation that makes the entire structure possible.
By pairing equity diversification with institutional real estate, Cache offers a modern exchange-fund approach that is:
- Faster to onboard
- Professionally managed
- Diversified across markets and property types
- Fully IRS-compliant
- Designed for long-term tax efficiency
In short: modern exchange funds combine market growth and tax deferral, backed by institutional-grade real estate.
The Cache Exchange Fund can help.
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