DST Provides Direction and Course of Action for Family Legacy

By Al DiNi­co­la

DST.Investments, LLC- Reg­is­tered Invest­ment Advi­sor

June 15, 2020

Finan­cial advis­ers, CPAs and Attor­neys inter­face with investors and pro­vide valu­able insight into plan­ning for gen­er­a­tional wealth trans­fer, occa­sion­al­ly ref­er­enced as a fam­i­ly lega­cy. This trust bond may have tak­en years to devel­op or may devel­op quick­ly with sound finan­cial advice.  Pro­fes­sion­als deal with sit­u­a­tions which may have recur­ring themes. How­ev­er, the pro­fes­sion­al must under­stand each and every sit­u­a­tion pri­or to sug­gest­ing the alter­na­tives. 

Recent­ly, we had the plea­sure of work­ing with a fam­i­ly and we were able to sug­gest alter­na­tives for their spe­cif­ic needs.  The patri­arch of the fam­i­ly had recent­ly passed away in his late 80’s. The matri­arch was in an assist­ed liv­ing facil­i­ty, in her mid-80’s and in fail­ing health.  Over the years, the patri­arch and matri­archic had assem­bled a real estate hold­ing port­fo­lio in a coastal Flori­da town.  The com­mer­cial and res­i­den­tial rental prop­er­ties served the fam­i­ly well for over twen­ty years. Some of the prop­er­ties were free and clear of any debt but there were a few with mort­gages on the prop­er­ties. One of the three sib­lings (now all in their 60’s) was charged with the respon­si­bil­i­ty of man­ag­ing the real estate. After 10 years of active man­age­ment of the assets, the man­ag­ing sib­ling was search­ing for an alter­na­tive.   The first alter­na­tive was to sim­ply sell all the real estate (on an accel­er­at­ed plan) and pay the cap­i­tal gains tax as well as recap­tur­ing all the depre­ci­a­tion and pay­ing the tax at a rate of 25%. The sec­ond was to attempt to do a 1031 Exchange and defer the tax­es.  The 1031 posed a few obsta­cles with the replace­ment of debt. The main obsta­cle was the matri­arch sign­ing on the loan for the debt replace­ment. 

The fam­i­ly was look­ing for a source of month­ly income, with­out the stress of man­age­ment or even deal­ing with a man­age­ment com­pa­ny in the case of an indi­vid­ual com­mer­cial build­ing with a Triple New Lease (NNN).  The fam­i­ly also under­stood that out­right sell­ing the real estate while the moth­er was still liv­ing may for­feit the step up in basis to cur­rent val­ue.  For those not famil­iar with this pro­vi­sion this is the read­just­ment of the val­ue of an appre­ci­at­ed asset for tax pur­pos­es upon inher­i­tance. This would mean the prop­er­ty own­er would pass own­er­ship upon their death. This min­i­mizes the cap­i­tal gain tax­es that may be due.  In the case of this fam­i­ly, the tax­es that would have been due were just under $1.6MM if the prop­er­ty was sold out­right and not pass to the heirs.

There still is a need for the moth­er to receive some sort of month­ly income. The oth­er fact would be the three sib­lings will even­tu­al­ly inher­it the asset (prop­er­ty). The solu­tion was to exe­cute a 1031 tax deferred exchange and pur­chase a vari­ety of DST assets which all includ­ed remov­ing man­age­ment con­cern as well as the debt replace­ment. We ana­lyzed the pro­posed clos­ing state­ment from the sale of the invest­ment prop­er­ties. There were four total invest­ment prop­er­ties that were to be exchanged.  We ana­lyzed the pay­off of the loans on the prop­er­ties since one of the require­ments of a 1031 is the debt needs to be replaced.  The DST also pro­vide non-recourse debt. This means there is no require­ment to sign for the loan that is in place for the DST. We also eval­u­at­ed the amount of equi­ty that would be avail­able for acqui­si­tion of the DSTs. We coun­seled the sib­lings on the selec­tion of a Qual­i­fied Inter­me­di­ary (QI) to hold the funds. All trans­ac­tions must be through a QI.

The result was a diver­si­fied port­fo­lio of mul­ti­ple DSTs in a vari­ety of assets and geo­graph­ic loca­tions. While the DST are oper­at­ing the moth­er receives month­ly income direct­ly into her account. Since there are mul­ti­ple DST and more than like­ly dif­fer­ent peri­ods of even­tu­al sales of the DST the fam­i­ly can eval­u­ate what the next steps would be at that time. If the moth­er is still liv­ing the fam­i­ly can do suc­ces­sive 1031 exchanges into oth­er DST or even out of the DST back into reg­u­lar real estate. These addi­tion­al alter­na­tives pro­vide addi­tion­al flex­i­bil­i­ty. The fam­i­ly can now enjoy the best of both worlds the dis­clo­sures of a secu­ri­ty and the tax advan­tages of real estate. 

When the moth­er pass­es away, the assets trans­fer to the sib­lings with a step up in basis for tax pur­pos­es.  Each sib­ling can be assigned a dif­fer­ent DST for their own accounts. The sib­lings would receive the month­ly income from the DST dur­ing the life of the DST. Once the DST reach­es full term and is sold the sib­lings would be in line to receive the pro­ceeds from the DST. The sib­lings would have a vari­ety of options on the dis­po­si­tion of the asset once the DST would be sold.  The indi­vid­ual sib­ling would receive the pro­ceeds from the DST. The indi­vid­ual sib­lings would be free to take the pro­ceeds with the added fac­tor of a step up in basis.    

As always con­sult your CPA or finan­cial advis­er.  We spe­cial­ize in DST struc­ture and func­tion.

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