Estate Planners expand client options with DSTs.
Certified Exit Planner Advisors (CEPAs) often face many issues with business owners anticipating selling their business as well as the real estate owned that often may accompany the business.
By Al DiNicola, AIF®, CEPA ™
DST 1031 Specialist
NAMCOA® – Naples Asset Management Company®, LLC
Securities offered through MSC-BD, LLC
CEPAs interact with CPAs, attorneys and other financial professionals to identify the best alternatives on the structuring and sale of the business. Over the years many investors seek the best structures for efficient tax planning. Utilizing the 1031 tax deferred exchange program with the Delaware Statutory Trust (DST) has become very popular. The DST is a tax advantaged investment that can utilize the 1031 exchange benefits as well as the passive nature of real estate ownership. It is no wonder why DSTs are part of the exit planning discussion.
Often a business owner contemplates selling their business or keeping the business in the family. Unfortunately, statistics show family transition is successful 30% of the time when transferring to the second generation of ownership and 12% when moving to the third generations. For those businesses who do have a family transition congratulations on your success. When a business sells, typically the adjusted EBITDA would be multiply by an industry multiple to arrive at a potential selling price. There would be a range of multiples established by the private equity markets and all companies don’t sell for the same multiple. There may also be a real estate component to the business that could be a 1031 tax deferred exchange benefitting the business owner.
Who is the (new) boss?
Occasionally we as financial advisors will meet with attorneys to review strategies on estate planning. Often we hear the stories typically revolving around financial issues once the remaining matriarch or patriarch has passed away. Thankfully the heated discussions are well after the funeral services. There are investors who seek advice (while still living) on structuring their real estate holdings and repositioning the assets. The thought of inheriting the parents’ investment property is a double edge sword for some families. The real estate may represent a valuable asset but at the same time may require a lot of management and oversight.
Forward thinking Investors.
We have interviewed several investors who may be considered forward thinking investors. One individual investor who has three children decided to sell his one larger investment property and utilize a 1031 exchange. The investor exchanged (tax deferred) into three DSTs with the intent of providing each child with the DST when he passes. His initial intention was to move from active management of the real estate holdings into a more passive role. While he owns the property he enjoys the passive nature of the DST structure along with the potential distributions and potential appreciation. In his forward thinking and planning he wanted to provide an easy option for each of his children when they inherit the property. In theory each of the children will ultimately inherit a DST and when the time comes can decide what they do with their part of the estate.
Can you manage a property from a thousand miles away?
We receive calls from older children who are attempting to assist their elderly parents manage rental property. Recently two daughters (one in Texas and the other in Florida) are attempting to manage their parents rental property in Illinois. One of the big advantages of the DST is the passive nature of the investment that includes full management of the property. For the daughters mentioned in this example this would eliminate all property management as well as all the bookkeeping and other task associated with owning investment real estate. Living in Florida and worrying about frozen pipes in Illinois can create a tremendous amount of anxiety. Worrying about property management when the daughters transition to being heirs may be totally eliminated.
Capital Gains & Step Up.
There could be a tremendous difference between an investor selling without a 1031 tax deferred exchange and with a 1031 tax deferred exchange. Here is a quick example. Hypothetically if an investor (while they are living) sells a $1 M property that originally cost $250,000, they could pay as much as 40% in capital gain taxes. This would be a combined tax on the recaptured depreciation taken on the property as well as federal and state (if applicable) capital gains tax on the profit. If the investor exchanges out of their current investment property not only do they eliminate the management responsibilities but also can diversify into several different asset classes. Inevitably the investor will leave this earth and there is a step up in basis the heirs would enjoy. So, what would that mean? In the example of the $1M property above if that property was exchanged into three DSTs (with no appreciation in value) there would be a step up from the $250,000 original value to $1M. If the recipient of the property were to sell the property for $1M that would be considered the new original price and no recapture of depreciation or capital gains taxes would be due. All of the children mentioned in the example would own each of their DSTs and continue to receive the distributions and tax benefits each DST would provide. When it became time for the DST to sell (occasionally referenced as going full cycle) each child may enjoy the benefits and collect proceeds tax free. We need to mention at this time there may be a tax the beneficiaries or heirs may not avoid. Everything in the investor’s estate at the time of their death would be subject to any estate tax or exclusions. The estate planner may suggest alternative methods to minimize taxes and maximize proceeds flowing through to the beneficiaries.
Charitable Contribution Option
Charitable contribution options may be reviewed by estate planners. Charitable giving has been considered to be a part of a well-rounded estate plan. Donor Advised Funds and potentially Charitable remainder trust have been identified by many planners as an excellent option. Charities do benefit from real estate gifts and DSTs may fall right into the preferred options because of the passive nature and potential distribution. Charities do not want to be responsible for the management of the property. Upon the full cycle event the charity may realize profits from the sale. If charities are faced with management of a property versus the sale of the property, the charity may look at simply selling no matter what the current market reflects on the value. A premature sale may reduce the amount received by the charity. The charity will benefit from holding the asset, receiving any distributions, and then benefit from the sale without having the pressure to actively manage the properties.
Education and preparation are the keys to estate planning.
The 1031 tax deferred exchange process may be difficult to understand and navigate. How a DST may benefit investors and benefit estate planning should be identified. NAMCOA engages with investors, CPA, attorneys, and other financial professional to evaluate each investor’s suitability for DST investment. Contact us for a conversation regarding your needs.
DSTs are not for all investors. The acquisition of a DST is for accredited investors only. Contact your investment adviser for additional details on how a DST may be a solution to your 1031 Exchange and suited for your investment future. 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 email firstname.lastname@example.org.
This is not an offer to purchase or solicitation to purchase any security, as such be made only through an offering memorandum or prospectus. Investing in securities, real estate, or any investment, whether public or private, involves risk, including but not limited to the potential of losing some or all of your investment dollars when you invest in securities. You should review any planned financial transactions that may have tax or legal implications with your personal tax or legal advisor. NAMCOA, LLC is a Registered Investment Advisor, regulated by SEC (Securities and Exchange Commission). Our corporate office is located at 999 Vanderbilt Beach Road, Suite 200, Naples Florida 34108. Securities Offered through MSC-BD, LLC, Member of FINRA/SIPC. 8215 SW Tualatin- Sherwood Rd, Suite 200, Tualatin, OR 97062. MSC-BD, LLC and NAMCOA are independently owned and are not affiliated.
NAMCOA® – Naples Asset Management Company®, LLC