Commercial Broker “Adds Value” to Their Customer’s Experience with the Suggestion of a DST

Al DiNi­co­la DST Invest­ment LLC — Reg­is­tered Invest­ment Advi­sors

Decem­ber 2019

Com­mer­cial real estate bro­ker are experts at their craft.  Real estate agents who con­tin­ue their edu­ca­tion and achieve a CCIM (Cer­ti­fied Com­mer­cial Invest­ment Mem­ber) des­ig­na­tion pro­vide added exper­tise to the analy­sis, list­ing, and sell­ing of real estate asset for their cus­tomers and investors. Often, the real estate agents are com­mend­ed for sug­gest­ing a solu­tion to a sell­er which may be at first total­ly “out of the box”. 

Let me share with you one real-life eye-open­ing exam­ple.   Recent­ly, a real estate agent con­vinced a prop­er­ty own­er (in their late 70’s) to sell their com­mer­cial asset.  This was an asset the own­er had devel­oped and active­ly oper­at­ed for a peri­od of over 10 years.  The com­mer­cial agent set the stage for the own­ers to sell the prop­er­ty and exe­cute a 1031 tax deferred exchange to avoid (defer) pay­ing the cap­i­tal gains tax.  At first the own­er was excit­ed to defer pay­ing the cap­i­tal gains tax. The own­er had acquired the raw land for $500,000 and then obtained a con­struc­tion loan for $2,200,000 to build facil­i­ty. The prop­er­ty own­er, although mar­ried, held the prop­er­ty in his own name through an LLC. Total Invest­ed $2,700,000. The com­mer­cial agent con­vinced the own­er to sell prop­er­ty for $5,600,000. The prop­er­ty own­er (and his wife) were very hap­py with the sale.

Then the CPA start­ed to cal­cu­late the poten­tial gains and tax­es that may be due upon the sale with­out a 1031 exchange. After sales cost the net sell­ing price was $5,300,000. The cap­i­tal gains would be $2,600,000 (after tak­ing into account the ini­tial $500,000 the sell­er paid for the land).  The tax­es at a total rate of 23.8% would be equal to $618,800. Recap­ture depre­ci­a­tion on the struc­ture was cal­cu­lat­ed at $200,000. Total Tax­es for this one trans­ac­tion, of $818,000 would be due if a 1031 was not used.  That would have reduced the prof­its from $2,6000,000 to $1,782000.  Still a nice sum of mon­ey to take as prof­it.  They want­ed to seek an alter­na­tive and retain the $818,000.

This CPA took the time to explain to the client, what would hap­pen when the own­er trans­ferred own­er­ship (upon his death) to his heirs.  There would be a step up in basis to cur­rent val­ue and all of the deferred tax­es may be elim­i­nat­ed.  Using a 1031 now would cre­ate addi­tion­al wealth for the sur­viv­ing spouse (or heirs) as there would have an addi­tion­al $818,800 in equi­ty pre­served. See­ing this is black and white was eye open­ing to the sell­er. The con­tract for the sale of the prop­er­ty was exe­cut­ed and clos­ing on the prop­er­ty occurred. The pro­ceeds were sent to a Qual­i­fied Interne­cia­ry (QI) which is one of the require­ments for a 1031 exchange. Post-clos­ing the real estate agent attempt­ed to locate replace­ment prop­er­ties. The 45-day clock starts tick­ing. One of the IRC 1031 require­ments is to replace the debt com­po­nent of $2,200,000. The agent locat­ed sev­er­al prop­er­ties includ­ing a Triple Net prop­er­ty (NNN). The agent is excit­ed to present the alter­na­tives to the sell­er.  How­ev­er, the seller’s spouse (even though not on the title) does not want her hus­band at his age to take on any respon­si­bil­i­ty for anoth­er loan (she felt this loan would be “the noose around my neck”), espe­cial­ly in the amount of $2,2000,000.

The real estate agent fails to con­vince sell­er to iden­ti­fy replace­ment prop­er­ty that does includes a “non­re­course” loan.  At this point the rela­tion­ship between the real estate agent and the sell­er becomes very ten­u­ous.  The sell­er was expect­ing to put $2,6000,000 to work in con­ser­v­a­tive real estate asset and col­lect income each month.  No mat­ter how hard the agent looked she could not locate a com­mer­cial prop­er­ty that did not require some sort of recourse loan even for part of the deal. There was a del­i­cate bal­ance between the total pur­chase price, using the cash pro­ceeds of the sale, and bal­anc­ing the debt replace­ment. Time was run­ning out for the sell­ers and the real estate agent. The sell­er was faced with writ­ing a check to the IRS in the amount of $818,800.

How­ev­er, that real estate agent had attend­ed a sem­i­nar on Delaware Statu­to­ry Trusts (DSTs).  She nev­er thought she would need to sug­gest this exit strat­e­gy.  Sim­ply put, since this is a secu­ri­ty offer­ing, she is not eli­gi­ble to par­tic­i­pate in earn­ing any com­mis­sion.  She want­ed to find a way her cus­tomers could avoid writ­ing the check for cap­i­tal gains thus uti­liz­ing all the pro­ceeds from the sale for acqui­si­tion of income pro­duc­ing real estate. Just as impor­tant was seek­ing a solu­tion for the sell­er since she con­vinced him to sell the prop­er­ty in the first place.   Instead the client con­tact­ed an invest­ment advi­sor who spe­cial­ized in DST offer­ings.

What she and the sell­ers found was a very clean solu­tion for the seller’s sit­u­a­tion. DSTs are “pre-pack­aged” designed for sell­ers of real estate who are exit­ing their prop­er­ties using a 1031 exchange. The DST spon­sors offer a vari­ety of prop­er­ties in all assets class­es that may include some com­po­nent of debt.  How­ev­er, the debt that is attached to the assets are non-recourse to the investors. Mean­ing in the above exam­ple the entire pro­ceeds may be invest­ed in a DST and with the right com­bi­na­tion of loan to val­ue the debt com­po­nent can be sat­is­fied.  For the spouse there is “no noose around the neck”.

Rather than the sell­er writ­ing a check for $818,800 tax­es he iden­ti­fies assets in a DST total­ing $5,3000,000 (the net sales price of the prop­er­ty). He acquires the DST assets with the cash of $2,600,000 and sat­is­fies a debt com­po­nent of $2,200,000. What is even more appeal­ing is the abil­i­ty to diver­si­fy the new prop­er­ties.  The CPA and QI are aware of the 200% rule in the iden­ti­fi­ca­tion process. The invest­ment advis­er cre­at­ed a port­fo­lio of DSTs pro­vid­ed by Spon­sors the sell­er can review.  The most impor­tant action was to include the DSTs on the 45-day noti­fi­ca­tion to the QI. Once iden­ti­fied the sell­er can review all the due dili­gence mate­ri­als with the Invest­ment Advis­er after the 45-day peri­od and pri­or to the 180-day manda­to­ry clos­ing require­ments. Once the final reviews take place the sell­er then clos­es on the spe­cif­ic selec­tion of DST assets.  

The sell­er iden­ti­fied DST assets in the mul­ti fam­i­ly, senior liv­ing and self-stor­age sec­tors. All the cash pro­ceeds are used, the debt com­po­nent is sat­is­fied, and the sell­er has a diver­si­fied port­fo­lio of real estate. These assets pro­duce month­ly income while the assets are owned and have the poten­tial for appre­ci­a­tion upon sale of the DST by the spon­sor.

There are many oth­er aspects of the DST that are worth fur­ther research.  Rel­a­tive­ly speak­ing, DST are rather new (20 years) but are gain­ing pop­u­lar­i­ty for retain­ing and cre­at­ing wealth.

For more infor­ma­tion on how to prop­er­ly set up an IRC 1031Tax Deferred Exchange or if you are an accred­it­ed investor and would like addi­tion­al infor­ma­tion on a DST con­tact Al DiNi­co­la at 239–691-8098 or vis­it www.dst.investments