The Right Investor for a DST investment

This is a hypo­thet­i­cal sto­ry about Jack & Diane. Two Amer­i­can investors (from Geor­gia) doing the best they can. Sound famil­iar? Life goes on.

By Al DiNi­co­la, AIF®, CEPA ™
adinicola@namcoa.com
Feb­ru­ary 20, 2023
DST 1031 Spe­cial­ist
NAMCOA® — Naples Asset Man­age­ment Com­pa­ny®, LLC
Secu­ri­ties offered through MSC-BD, LLC

Own­ers of a real estate prop­er­ty who have active­ly man­aged their indi­vid­u­al­ly owned sin­gle prop­er­ty may face the music at a point in time. The music at a cer­tain point in time may be when you least expect it receive an offer to sell your prop­er­ty. Sud­den­ly you may be con­sid­ered a real estate investor rather than a sin­gle prop­er­ty own­er. Dur­ing the time they held the prop­er­ty Jack enjoyed the income, at times Diane enjoyed over­see­ing the man­age­ment of the prop­er­ty. They may be will­ing to reen­gage with a new prop­er­ty if they sell their prop­er­ty. Dur­ing the time they owned the prop­er­ty they invest­ed addi­tion­al cap­i­tal to improve the prop­er­ty. They inter­view good poten­tial ten­ants but did have turnover but lit­tle dam­age. The prop­er­ty has increased in val­ue over the past dozen years of their own­er­ship. They orig­i­nal­ly paid $475,000 for the prop­er­ty and have a con­tract for $995,000 which they have accept­ed.  Over the time Jack & Diane owned the prop­er­ty they both decid­ed they want to get out of man­age­ment and look­ing for a more pas­sive role in own­er­ship.

Stick­er shock with cap­i­tal gains tax­es.

Their rela­tion­ship with the CPA main­ly focused on their per­son­al income tax­es with your com­bined income between Jack & Diane. Jack was a for­mer small col­lege foot­ball play­er and now a col­lege coach and Diane is a pro­fes­sor at the same col­lege. They have a com­bined income of over $425,000 for the past three years. The income from the sin­gle rental prop­er­ty was very nice and their CPA did account for own­er­ship expens­es as well as the depre­ci­a­tion sched­ule. This helped to off­set some of the income pro­vid­ing some tax shel­ter relief.  They orig­i­nal­ly acquired the prop­er­ty for $475,000 which required a 30% down­pay­ment ($142,500) and both signed on the loan of $332,500.

The CPA pro­vid­ed the poten­tial pay­out.

• Sales price $995,000
• Loan pay­off $246,600 (after 12 years of prin­ci­ple & inter­est pay­ment)
• Gross Sales Pro­ceeds $748,400
• Cost of sale 7% $69,650 (real estate com­mis­sion and clos­ing cost)
• Net pro­ceeds $678,750 (before tax­es)
• Depre­ci­a­tion tak­en $186,500 (12 years) taxed at 25%= $46,636.
• Cap­i­tal Gains on $678,750 -$186,500= $492,250 @ 20% = $98,450
• Afford­able care tax at 3.8% = 18,750
• Geor­gia State Income tax at 5% = $35,000
• Total tax­es: $198,800
• Net pro­ceeds: $479,950

Invest­ing the $479,950 at a hypo­thet­i­cal rate of 4%=$19,198.  Long after the thrill of own­ing the prop­er­ty… is there a bet­ter option?

CPA very aware of a poten­tial DST option.

Their CPA attends con­fer­ences and con­tin­u­ing edu­ca­tions on strate­gic options for their clients. The CPA men­tioned  a strat­e­gy that would com­bine a 1031 tax referred exchange along with a Delaware Statu­to­ry Trust (DST). The DST nature of pas­sive invest­ing may work well for investors who do not want to be involved in the man­age­ment of real estate.

Where did DST come from?

Delaware Statu­to­ry Trust (DST) was cre­at­ed under Delaware Statu­to­ry Law. This per­mits investors to invest in a frac­tion­al own­er­ship along with oth­er investors in a much larg­er insti­tu­tion­al type invest­ment that typ­i­cal­ly the indi­vid­ual investor would not be able to invest.   DSTs have been around for about 20 years and are becom­ing more pop­u­lar. 1031 exchanges have been around for a hun­dred years.

What is a DST?

A DST is an assigned frac­tion­al inter­est in real estate com­prised of an equi­ty posi­tion and assigned amount of debt if applic­a­ble. In order for a 1031 exchange to be valid you need to not only use your cash pro­ceeds but if you paid off a mort­gage when you sold that would also need to be replaced.

Who Should Invest in a DST?

Indi­vid­u­als seek­ing to diver­si­fy find a solu­tion with a DST. The rel­a­tive­ly low cost to invest in a DST ($25,000 for cash investors and $100,000 for 1031 exchange investors) enable an investor to par­tic­i­pate in much larg­er, insti­tu­tion­al grade real estate that sim­ply is out­side the grasp of most investors. In addi­tion, the low­er entry dol­lar lev­els enable investors to par­tic­i­pate in a vari­ety of assets in dif­fer­ent class­es as well as dif­fer­ent geo­graph­i­cal loca­tions.  As a note, diver­si­fi­ca­tion does not elim­i­nate all risk but does spread risk out among dif­fer­ent types of invest­ments as well as dif­fer­ent phys­i­cal loca­tions.

Mov­ing from Active to Pas­sive man­age­ment

The baby boomers have reached the age where they may want to spend more time away from active­ly man­ag­ing their real estate hold­ings.  Mov­ing out of an active role to a more pas­sive role has many advan­tages. More time spent in trav­el­ing and less time with ten­ants seems to be one of the advan­tages.

Oh yeah, Life goes on.

There are many poten­tial exit options for cur­rent real estate hold­ings. The investor who may be reluc­tant to list and sell their prop­er­ty (because of cap­i­tal gains impli­ca­tions or lim­it­ed rein­vest­ment options) has mul­ti­ple exit options or strate­gies on replace­ments with the wide vari­ety of DSTs. The vari­ety includes asset class as well as geo­graph­ic loca­tions. The exit options may pro­vide a defer­ral of cap­i­tal gains while the investor is liv­ing and poten­tial­ly total cap­i­tal gains elim­i­na­tions for the heirs.

More insight into a 1031 Exchange

Many CPAs are knowl­edge­able about 1031 exchange and how an investor may ben­e­fit.  WE have found few­er CPAs are well versed in the abil­i­ty to include DST prop­er­ties whether as their includ­ed pref­er­ences to acquire or as a back­up strat­e­gy.  WE have guid­ed many investors on how to include the DST options on the 45-day iden­ti­fi­ca­tion form (pro­vid­ed by the Qual­i­fied Inter­me­di­ary QI) and required for com­pli­ance by the IRC 1031

Estate Plan­ning Options

As a Cer­ti­fied Exit Plan­ning Advi­sor, we often answer ques­tions regard­ing estate plan­ning. The DST may fall into a poten­tial estate plan­ning buck­et for real estate owned by the busi­ness own­er or investor. While the investor is liv­ing, they will con­tin­ue to receive dis­tri­b­u­tion. When the investors pass, and the heirs receive the prop­er­ty they will receive the dis­tri­b­u­tion. Upon the sale of the prop­er­ty there will be a step-up in basis to cur­rent val­ue that may elim­i­nate cap­i­tal gains tax­es and recap­ture of depre­ci­a­tion.  There still may be an estate tax on the inher­i­tance.

Gen­er­ate Pas­sive Income for Investors

The enti­ty that cre­ates the DST are called spon­sors. Spon­sors secure the prop­er­ty, con­duct due dili­gence, arrange for poten­tial bank financ­ing and hire the attor­neys to put togeth­er the Pri­vate Place­ment Mem­o­ran­dums (PPM) required by secu­ri­ties law. Once this hap­pens the offer­ings may be acquired by investors.  Investors look­ing for pas­sive income find that lack of respon­si­bil­i­ty to be active­ly involved in the oper­a­tions of the prop­er­ty and at the same time enjoy month­ly dis­tri­b­u­tion does check many of the required  invest­ment box­es.

Most DST are out of reach the finan­cial reach for an Indi­vid­ual Investors 

Typ­i­cal­ly, DSTs range in offer­ing price between $10 M to over $100M.  For the aver­age investors acquir­ing this lev­el of prop­er­ty would require an investor to hit the Power­ball jack­pot.  How­ev­er, DST afford the aver­age Accred­it­ed investor the abil­i­ty in invest in insti­tu­tion­al grade mul­ti­mil­lion-dol­lar prop­er­ties. A DST is a frac­tion of the price with a frac­tion­al own­er­ship ben­e­fit­ting mul­ti­ple investors at the same time.

What about Jack & Diane?

 As with all ini­tial calls with investors there are a series of ques­tions we attempt to ask.  We want to under­stand the goals & objec­tives. There are ques­tions about risk tol­er­ance and suit­abil­i­ty.

For Jack & Diane the poten­tial solu­tion was to uti­lize an IRC Sec­tion 1031 tax deferred exchange. In addi­tion, the DST as an accept­ed replace­ment prop­er­ty pro­vid­ed the pas­sive invest­ment solu­tion they were seek­ing. Because of their annu­al income lev­el, they qual­i­fy as an accred­it­ed investor (required for a DST).

• The sell­ing price of $995,000 still had a cost of sale of 7% 
• Cost of sale 7%= $69,650 (real estate com­mis­sion and clos­ing cost)
• Net pro­ceeds = $925,350.
• Four DST can be acquired (two all cash and two with non-recourse lever­age)
  • Two mul­ti­fam­i­ly apart­ments (locat­ed in Flori­da)
  • One self-stor­age (locat­ed in Texas)
  • One indus­tri­al (locat­ed in Ten­nessee)
• Hypo­thet­i­cal income pro­ject­ed at $37,000 annu­al­ly.
• Tax advan­taged income (depre­ci­a­tion and inter­est write offs)
• Total tax­es deferred: $198,800.

Objec­tives attained:

• Defer­ral of cap­i­tal gains
• More invest­ment dol­lars at work
• Geo­graph­ic and asset class diver­si­fi­ca­tion
• Pas­sive income

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 adinicola@namcoa.com.

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.

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Thank you.

NAMCOA® — Naples Asset Man­age­ment Com­pa­ny®, LLC