§ 721 UPREIT Mission Possible via DST  

The term  Real Estate Invest­ment Trust (REIT) has been around for a long time.  You may trace the roots back to Pres­i­dent Eisen­how­er when leg­is­la­tion was passed by Con­gress enabling a new style of invest­ing includ­ing the attrib­ut­es of stock base invest­ments and real estate. Acqui­si­tion of a REIT is the Mis­sion.  

By Al DiNi­co­la, AIF®, CEPA ™
adinicola@namcoa.com
July 14, 2023
DST 1031 Spe­cial­ist
NAMCOA® — Naples Asset Man­age­ment Com­pa­ny®, LLC
Secu­ri­ties offered through MSC-BD, LLC

REITs pro­vid­ed an oppor­tu­ni­ty to invest in high qual­i­ty real estate with oth­er like-mind­ed (unknown) investors. Over the past 60 plus years the struc­ture and func­tions of REIT have evolved. There may be a vari­ety of assets or prop­er­ties that make up the REIT port­fo­lio. REITs may be pub­lic or pri­vate. Pub­lic REITS would trade on the nation­al stock exchange.  REITs would be con­sid­ered pas­sive invest­ments because the port­fo­lio is pro­fes­sion­al­ly man­aged along with require­ments of dis­tri­b­u­tions to be made to the investors.

The Mis­sion: Acquir­ing a REIT

Cash investors may invest direct­ly into a REIT and enjoy the tax advan­tage that many investors seek. Real estate investors have a few options to par­tic­i­pate in a REIT.  An indi­vid­ual prop­er­ty own­er may con­tribute their prop­er­ty to a REIT. This is known as a 721 UPREIT. Gen­er­al­ly, the con­tri­bu­tion investor trans­fers the real estate prop­er­ty into the REIT (oper­at­ing part­ner­ship) and would receive “units” in return. For the pur­pos­es of this writ­ing, we will not dis­cuss the per­cent­age of con­tri­bu­tion and the per­cent­age of units an investor may receive in return.   Tech­ni­cal­ly the investor is mov­ing from real estate which is con­sid­ered real prop­er­ty into a REIT which is con­sid­ered a secu­ri­ty.   The oth­er option a real estate investor may use to con­vert their real estate into a REIT would be to enter into a process involv­ing a 1031 tax deferred exchange. You may not uti­lize a 1031 exchange (direct­ly) into a REIT in one step and imme­di­ate­ly. As a reminder the 1031 exchange must be uti­lized when exchang­ing like kind prop­er­ty (real prop­er­ty) held for invest­ment or busi­ness pur­pos­es. REITS falls under the clas­si­fi­ca­tion of per­son­al prop­er­ty.    How­ev­er, it is pos­si­ble to move into a REIT in a few steps.

Mis­sion Strat­e­gy: DST.

 The strat­e­gy involves uti­liz­ing a Delaware Statu­to­ry Trust (DST).    DSTs began their pop­u­lar­i­ty start­ing in 2004. This may be a rel­a­tive­ly new strat­e­gy for some investors.  DSTs in many cas­es have replaced Ten­ants in Com­mon (TIC) for frac­tion­al own­er­ship. Rev­enue Rul­ing 2004–86 (IRS),  specif­i­cal­ly ref­er­enced a DST as a like-kind invest­ment for a 1031 exchange. Investors may uti­lize the DST as the replace­ment prop­er­ty via 1031 exchange when sell­ing their invest­ment prop­er­ty.   Con­vert­ing the real estate into a DST moves the investor one step clos­er to a REIT invest­ment, if that is the ulti­mate goal.

DSTs offer investors the abil­i­ty to diver­si­fy their real estate hold­ings into dif­fer­ent select­ed asset class­es or geo­graph­ic loca­tions. The investor would own a ben­e­fi­cial inter­est in the Trust. The ben­e­fi­cial inter­est qual­i­fies as a 1031 exchange just like any tra­di­tion­al real estate used as a replace­ment prop­er­ty in a 1031.   The first part of the mis­sion has been accom­plished by mov­ing into a DST.

Mis­sion Crit­i­cal Options

When DSTs are pre­pared to be sold by the spon­sors, the sale may be ref­er­enced as a liq­uid­i­ty event. There are typ­i­cal­ly three exit strate­gies: sim­ply col­lect your pro­ceeds and pay cap­i­tal gains; uti­lize a 1031 exchange into anoth­er DST, and; uti­lize a 1031 exchange and move back into a tra­di­tion­al real estate hold­ing.  Recent­ly a fourth option has been intro­duced by cer­tain spon­sors of DSTs.  Some spon­sors have affil­i­a­tions with large insti­tu­tion­al REITS that pro­vide investors with the option to move into a REIT uti­liz­ing what is known as §721 UPREIT.

Mov­ing the Mis­sion For­ward

The sec­ond part of the mis­sion would be to move into the REIT. The exact tim­ing of the sec­ond part may be some­what flu­id. The abil­i­ty to move into the REIT will be deter­mined when the liq­uid­i­ty event occurs (also known as the DST going full cycle).   Mov­ing into the REIT is a well thought out goal for more than one rea­son.  The liq­uid­i­ty event is deter­mined by the spon­sor.  There is also what may be ref­er­enced as a safe har­bor or hold­ing peri­od. Typ­i­cal­ly, DST spon­sors will seek to hold the assets with­in the indi­vid­ual DST for a peri­od of time.  The hold­ing peri­od may be tied to recov­er­ing any acqui­si­tion cost asso­ci­at­ed with the struc­ture of the DST.  Two to three years may be an ade­quate peri­od of time in cer­tain sit­u­a­tions.

If the investor’s over­all mis­sion is to defer cap­i­tal gains, then the DST does accom­plish this and mov­ing into the REIT may pro­vide oth­er solu­tions as well. This is not intend­ed to be a knee jerk activ­i­ty.   

Mis­sion Review

Here is a review of the mis­sion (if you accept). Investors sell prop­er­ty uti­liz­ing a 1031 exchange. The pro­ceeds go to a Qual­i­fied Inter­me­di­ary (QI).  The investor iden­ti­fied DST prop­er­ties (with­in the required 45-day iden­ti­fi­ca­tion peri­od) and QI funds the acqui­si­tion. When the DST is sold in a few years the investor can direct the pro­ceeds into the REIT. The investor will own Oper­at­ing Part­ner­ship Units (OP).  What have you gained from  your mis­sion?  You deferred cap­i­tal gains on the 1031 exchange into the DST.  When you con­vert­ed into the REIT you paid no tax­es on the con­ver­sion.   As long as you own the REIT you will pay no cap­i­tal gains tax­es.  How­ev­er, you will be respon­si­ble for pay­ing any tax­es on the income that is dis­trib­uted from the DST or the REIT based on your per­son­al income tax brack­et as well as state of res­i­dence.  If the end mis­sion is for the REIT to become part of your estate to be passed down your ben­e­fi­cia­ry will enjoy a step up in basis and not be sub­ject­ed to any cap­i­tal gains tax­es.

Post Mis­sion Fall Out, If any

You suc­cess­ful­ly com­plet­ed your mis­sion of con­vert­ing your real estate into a 721 UPREIT (via 1031 & DST exe­cu­tion). Once you have moved into a REIT you can­not uti­lize anoth­er 1031 exchange again.  Fed­er­al and state tax­es (if applic­a­ble) will be due if you sell your REIT.  There is also a safe hold­ing peri­od of 1–2 years to own the OP Units pri­or to sell­ing. There is an advan­tage if you were to sell your REIT you may peel off some of your units and not liq­ui­date the entire REIT port­fo­lio. This is not the case with a DST. Some investors seek the added flex­i­bil­i­ty of the REIT.   There is a word of cau­tion as always.  Read the Pri­vate Place­ment Mem­o­ran­dum (PPM) or oth­er offer­ing doc­u­ments and ask ques­tions to your CPA and tax advi­sors. Over the past few years, the qual­i­ty of the DST offer­ings that con­tain the 721 UPREIT option has increased in offer­ings.

Suit­abil­i­ty

Exer­cis­ing the 721 UPREIT option is based on indi­vid­ual investor suit­abil­i­ty. NAMCOA has addi­tion­al insight into the DST struc­ture as well as the 721-con­ver­sion option. There are ben­e­fits to both strate­gies. If you have ques­tions, please con­tact us.

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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