DSTs and §1031 Exchanges: Understanding how DSTs can be part of a §1031 exchange for tax-deferred real estate transactions.

The U.S. Tax code has main­tained a pro­vi­sion in the code for over 100 years per­mit­ting tax­pay­ers to defer cap­i­tal gains. While the ref­er­ence to the sec­tion in the code has a few names, such as like kind exchange, stark­er exchange the inten­tion remains the same.

March 20, 2024

By Al DiNi­co­la, AIF®, CEPA™
DST 1031 Spe­cial­ist
NAMCOA® — Naples Asset Man­age­ment Com­pa­ny®, LLC
Secu­ri­ties offered through MSC-BD, LLC Mem­ber of FINRA/SIPC

Defer cap­i­tal gains tax­es on the sale of appre­ci­at­ed prop­er­ty. The investor must rein­vest the pro­ceeds in a qual­i­fy­ing replace­ment prop­er­ty. Since 2004 Delaware Statu­to­ry Trust (DSTs) have been deemed accept­able replace­ment vehi­cle for a 1031 exchange.

Replace­ment Prop­er­ty Iden­ti­fi­ca­tion:Tim­ing is imper­a­tive
in a 1031 exchange. There are no exten­sions. The investor has 45 days from the clos­ing on the prop­er­ty sold to iden­ti­fy poten­tial replace­ment prop­er­ties. This is the crit­i­cal first step (after the pro­ceeds from the sale of the relin­quished prop­er­ty are deposit­ed direct­ly to the Qual­i­fied Inter­me­di­ary (QI) by the clos­ing agent on the relin­quished prop­er­ty.

Replace­ment Prop­er­ty may be a DST:
The DST iden­ti­fied may be a sin­gle asset or it may be a port­fo­lio of assets. DSTs will be iden­ti­fied on the QI required form. There are rules on the num­ber of prop­er­ties an investor has. How­ev­er, the DST may be used in com­bi­na­tion with tra­di­tion­al real estate, a back­up prop­er­ty or even used to sat­is­fy any cash remain­ing (known as boot).

Frac­tion­al Own­er­ship (is not bro­ken):
The inter­est a DST investor owns in a DST is con­sid­ered frac­tion­al own­er­ship inter­ests in the trust or ref­er­enced as a ben­e­fi­cial inter­est. The Trust holds title to the real estate prop­er­ty or assets. The own­er­ship inter­est of each indi­vid­ual investor will be a per­cent­age or pro­por­tion­al share. Depend­ing on the actu­al dol­lars invest­ed.

Pas­sive Invest­ment Struc­ture:
The Trustee of the DST is respon­si­ble for the man­age­ment of the prop­er­ty. This pro­vides the investors with a pas­sive role and all the ben­e­fits of the pas­sive role. There are no man­age­ment respon­si­bil­i­ties required by the indi­vid­ual investors. The ben­e­fi­cial own­ers are relieved of any man­age­ment duties.

Diver­si­fi­ca­tion:
When an investor replaces the relin­quished prop­er­ty with one replace­ment prop­er­ty it may be because of equi­ty required for a replace­ment prop­er­ty.  Investors may also only have access to one mar­ket. This may be viewed as lim­it­ing diver­si­fi­ca­tion. The ben­e­fit of a DST is the low bar­ri­er to entry ($100,000) enabling an investor to uti­lize the same invest­ment dol­lars and allo­cat­ed to dif­fer­ent asset class­es or geo­graph­i­cal areas.  As a note diver­si­fi­ca­tion does not elim­i­nate risk but assists in mit­i­ga­tion.

Investors like Cash Flow:
Many investors look for invest­ment prop­er­ties that gen­er­ate income that results in cash flow. DST project dis­tri­b­u­tions typ­i­cal­ly month­ly. The reg­u­lar source of income would be dis­trib­uted once all the rents are received form the ten­ants, expens­es are paid (if applic­a­ble the mort­gage on the prop­er­ty) with the remain­ing income dis­trib­uted to the indi­vid­ual investors. DST investors may be direct cash investors or 1031 exchange investors.

Sec­tion 1031 Exchange Rules must be fol­lowed:
First and fore­most, the investor must use the ser­vices of an accom­moda­tor or more com­mon­ly known as a qual­i­fied inter­me­di­ary (QI).  The QI is an unre­lat­ed spe­cial enti­ty who will have an agree­ment with the investor sell­ing the prop­er­ty that is part of the exchange.  The agree­ment will spell out the terms of the trans­ac­tion which includes receiv­ing the pro­ceeds of the relin­quished sale and for­ward­ing the nec­es­sary amount to pur­chase the replace­ment prop­er­ty. The investor may not touch the funds, nor can an attor­ney or escrow agent hold the funds. If any­one oth­er than a QI hold the fund that is con­sid­ered con­struc­tive receipt of the pro­ceeds and will ter­mi­nate the 1031.

45 & 135 = 180:
Time may move quick­ly in a 1031 exchange.  Investors have 45dys to iden­ti­fy replace­ment prop­er­ties.  An addi­tion­al 135 days to close.  This is a total of 180 days from start to fin­ish.  Replace­ment prop­er­ties must be on the 45-days list and sub­mit­ted to the QI.

Lim­it­ed Liq­uid­i­ty Events:
The pro­ject­ed hold­ing peri­od of the DST is pro­ject­ed in the PPM. There is lim­it­ed liq­uid­i­ty for the investors. While there may be a poten­tial sec­ondary mar­ket investors need to be in a posi­tion to hold their posi­tions until the full cycle event (sale of the DST).

DST’s (Delaware Statu­to­ry Trusts) are for accred­it­ed investors only.  Con­tact your invest­ment advis­er for addi­tion­al details on how a DST may be a solu­tion to your 1031 Exchange and com­pli­ment your finan­cial objec­tives. 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, in any form, 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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