When to use an Opportunity Zone vs Delaware Statutory Trust

There are sub­tle dif­fer­ences between oppor­tu­ni­ty zones and Delaware statu­to­ry trust. Both of these invest­ment strate­gies are vehi­cles with tax ben­e­fits. How­ev­er, there are dif­fer­ent rea­sons for using each strat­e­gy and may serve dif­fer­ent pur­pos­es depend­ing on the investor.

August 24, 2024

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

Each investor should seek com­pe­tent pro­fes­sion­al help who under­stands the advan­tages of both pro­grams. Here is a com­par­i­son of each pro­gram.

Oppor­tu­ni­ty Zones (OZ)

Oppor­tu­ni­ty zones came about through the tax and jobs acts of 2017. They became effec­tive for the 2018 tax year. This spe­cif­ic pur­pose for des­ig­nat­ing areas of the coun­try as oppor­tu­ni­ty zones was to increase invest­ment and devel­op­ment in areas which were typ­i­cal low­er income areas. The areas known as cen­sus tracts were estab­lished by each state through the gov­er­nor of the state. Cur­rent­ly there are over 8,700 oppor­tu­ni­ty zones through­out the Unit­ed States, and this was reflect­ed from the 2010 cen­sus tracts.

Investors can defer, reduce, or even elim­i­nate cap­i­tal gains tax­es by invest­ing in Oppor­tu­ni­ty Zones. Investors are per­mit­ted to defer and, in some cas­es, reduce cap­i­tal gains tax­es by invest­ing in oppor­tu­ni­ty zones. The pro­gram has changed over the last five to six years because some of the small­er ben­e­fits or advan­tages to the investors have expired.

Under­stand­ing cap­i­tal gains. When the oppor­tu­ni­ty zone was estab­lished, invest­ment can be made into that vehi­cle by uti­liz­ing cap­i­tal gains from a vari­ety of sources. This could be from appre­ci­at­ed real estate that has been sold, it could be sell­ing col­lectible art, or it could be sell­ing appre­ci­at­ed stock. This is a defer­ral tem­porar­i­ly of cap­i­tal gains and not an elim­i­na­tion.

One of the con­sid­er­a­tions that needs to be made and estab­lished is the hold­ing peri­od for the oppor­tu­ni­ty zones in order to take advan­tage of max­i­mum ben­e­fits. The max­i­mum ben­e­fits that may be obtained from hold­ing an oppor­tu­ni­ty for a min­i­mum of 10 years would be the elim­i­na­tion of cap­i­tal gains on any of the pro­ceeds from the sale of the prop­er­ty or the invest­ment fund. If you do not plan on hold­ing the invest­ment for 10 years you would lose the eco­nom­ic ben­e­fit of elim­i­na­tion of cap­i­tal gains on any of the prof­its. This would be the elim­i­na­tion of Fed­er­al Cap­i­tal gains in almost all state cap­i­tal gains except for four states who. These states are con­sid­ered non-con­form­ing states with respect to elim­i­na­tion of cap­i­tal gains for state tax­es.

The over­all goal of the estab­lish­ment of oppor­tu­ni­ty zones and incen­tiviz­ing investors 2 invest in these areas is for the bet­ter­ment of the com­mu­ni­ty. Cer­tain areas or cen­sus tracts may not have been a first choice for investors when look­ing for poten­tial oppor­tu­ni­ties. How­ev­er, what we have seen over the past five years has been an increased amount of invest­ment con­tribut­ing to the revi­tal­iza­tion of com­mu­ni­ties.

Tax Ben­e­fits:

Defer­ral: Under the cur­rent leg­is­la­tion cap­i­tal gains tax­es are deferred until 2026 (payable April 2025) when you invest in an OZ.

Future Exclu­sion: If the investor holds the OZ invest­ment for 10 years (or more), cap­i­tal gains from the invest­ment may be poten­tial­ly exclud­ed.  There is no manda­to­ry sale of the invest­ment at the ten-year mark and investors may ben­e­fit from hold­ing on to the invest­ment to max­i­mize increased returns.

Risk and Liq­uid­i­ty:

Risk may be the first top­ic an investor ana­lyzes on any invest­ment.  The nature of oppor­tu­ni­ty zones that is invest­ment in eco­nom­i­cal­ly or under­de­vel­oped areas or even dis­tress areas may always be a con­cern.

Liq­uid­i­ty: Real estate has always been less liq­uid than oth­er invest­ments.  Investors may uti­lize real estate because it is non­cor­re­lat­ed to the oth­er mar­kets. In the OZ prop­er­ties there will be more time need­ed for devel­op­ments as well as the 10-year hold­ing peri­od to ful­ly gain the ben­e­fits.

Delaware Statu­to­ry Trust (DST)

Pur­pose:

Many investors uti­liz­ing a §1031 exchange will seek a DST as a solu­tion to own­ing real estate as well as com­pli­ance with the IRC rules for §1031 tax deferred exchanges.  The DST per­mits mul­ti­ple own­ers in a real estate prop­er­ty enabling the investor to acquire a frac­tion­al inter­est in a larg­er insti­tu­tion­al prop­er­ty.

When to Use:

§1031 Exchange: If your real estate has appre­ci­at­ed in val­ue and you expe­ri­ence a cap­i­tal gain result­ing in cap­i­tal gains tax­es investors may seek to defer those gains via a §1031. The defer­ral may also be on state and city tax­es as well as recap­ture of depre­ci­a­tion on the invest­ment prop­er­ty. Key dif­fer­ence between OZ and §1031 is the §1031 exchange is only good for real estate and no oth­er appre­ci­at­ed assets.

Pas­sive Income: one of the ben­e­fits of invest­ing in a DST is the elim­i­na­tion of man­ag­ing the prop­er­ty thus cre­at­ing a hands-off approach to real estate own­er­ship. This pas­sive real estate invest­ment may become espe­cial­ly advan­ta­geous as investors seek to spend time with alter­na­tive activ­i­ties rather than man­ag­ing real estate prop­er­ty.

Diver­si­fi­ca­tion: Investors seek­ing diver­si­fi­ca­tion of their real estate port­fo­lio, or their over­all port­fo­lio may seek out Delaware statu­to­ry trust. The DST by nature or struc­ture enables mul­ti­ple investors to own a frac­tion of a much larg­er insti­tu­tion­al grade prop­er­ty.

Ease of Use: The §1031 process may be dif­fi­cult to exe­cute, espe­cial­ly with the time con­straints that are imposed by the Inter­nal Rev­enue Codes. DSTs are prepack­aged and may be ref­er­enced as sit­ting on the shelf ready to go. In addi­tion, the DSTs, that are designed with lever­age, enables investors to replace the debt that is being paid off. Offer­ing non-recourse debt to the investor also cre­ates a very easy solu­tion for investors.

Tax Ben­e­fits:

§1031 Exchange: Many investors are seek­ing a method of defer­ring cap­i­tal gains to a lat­er point in time for a num­ber of rea­sons. Cap­i­tal gains may be off­set by cap­i­tal loss­es. The 1031 exchange enables investors, if they receive pro­ceeds from the sale of the prop­er­ty to defer cap­i­tal gains.

Step-Up in Basis: There is a point in time that an addi­tion­al ben­e­fit comes into play and that is upon the death of the investor. The heirs of the investor will receive what is known as a step up in basis to cur­rent val­ue of the real estate. Once this step up in bases hap­pens poten­tial­ly all cap­i­tal gains may be elim­i­nat­ed.

Risk & Liq­uid­i­ty:

Risk: Many investors may seek or view the DST as the low­er wrist when com­pared to the OZ. This may be because of the imme­di­ate cash flow that most DSTs pro­vide. Typ­i­cal­ly, DSTs pro­vide sta­ble income from income pro­duc­ing prop­er­ties.

Liq­uid­i­ty: There are gen­er­al­ly the same risks in DST as in all real estate invest­ments, mean­ing they are not eas­i­ly liq­ui­dat­ed. The DST has an addi­tion­al lim­i­ta­tion because the indi­vid­ual investor is not in total con­trol of the DST invest­ment. The spon­sors of the DST will make the deter­mi­na­tion of when the prop­er­ty will be offered for sale. Once the DST is sold the investor will have options to enter into future 1031 exchanges or oth­er alter­na­tives.

Sum­ma­ry

Investors seek­ing an oppor­tu­ni­ty zone need to ana­lyze what their cap­i­tal gains are from their appre­ci­at­ed assets. The unique ben­e­fit of the oppor­tu­ni­ty zone is the investor only needs to rein­vest the cap­i­tal gains and not the basis in the prop­er­ty. If a investor has uti­lized full depre­ci­a­tion of their prop­er­ty there may be no basis to retain tax free. The oth­er ben­e­fit of the oppor­tu­ni­ty zone is the invest­ment into the com­mu­ni­ty and the poten­tial impact that the com­mu­ni­ty would expe­ri­ence. The long term ben­e­fits would be the elim­i­na­tion of cap­i­tal gains tax­es when the OZ prop­er­ty would be sold.

Delaware statu­to­ry trusts work extreme­ly well for investors seek­ing to com­plete a 1031 exchange or sim­ply get involved with a real estate invest­ment they typ­i­cal­ly can­not com­plete on their own. The oth­er advan­tage of a DST is the pas­sive real estate income that one would derive. Cap­i­tal gains are deferred until the prop­er­ty is sold or poten­tial­ly lim­it­ed when there would be a step up in basis when the investor pass­es away.

Is 10 years too long? Over the past few years since the oppor­tu­ni­ty zones have come into play, we have field­ed many ques­tions regard­ing hav­ing to hold the prop­er­ty for 10 years as in the case of the oppor­tu­ni­ty zone to real­ize any of the ben­e­fits long term. When you com­pare the hold­ing. Of the OZ ver­sus a 1031 exchange using a Delaware statu­to­ry trust ten years may not seem that long. Investors that do mul­ti­ple 1031 exchanges over and over again may hold that inter­est for 30 or 40 years and passed the ben­e­fits of no cap­i­tal gains on to the airs. We are well versed in both pro­grams and would be hap­py to dis­cuss your spe­cif­ic sit­u­a­tion pri­or to mak­ing any invest­ment deci­sions.

Investor Restric­tion:

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. 

SOCIAL MEDIA

Social Media plat­forms are sole­ly for infor­ma­tion­al pur­pos­es. Advi­so­ry ser­vices are only offered to clients or prospec­tive clients where the advi­so­ry firm and its rep­re­sen­ta­tives are prop­er­ly licensed or exempt from licen­sure. Past per­for­mance is no guar­an­tee of future returns. Invest­ing involves risk and pos­si­ble loss of prin­ci­pal cap­i­tal. No advice may be ren­dered by NAMCOA unless a client ser­vice agree­ment is in place.