Preparing your CPA for the DST Investment

We con­grat­u­late all the CPAs we meet in con­tin­u­ing edu­ca­tion set­tings and meet­ings. We are encour­aged to see CPAs engag­ing with new infor­ma­tion to be more proac­tive.

Sep­tem­ber 10, 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

In a recent study and sur­vey of busi­ness own­ers it was found that over 72% of busi­ness own­ers would leave their CPA because the CPA is reac­tive rather than proac­tive.  It is no secret that the tax code is com­pli­cat­ed and not all CPAs can han­dle every invest­ment ven­ture.

 CPAs that work pri­mar­i­ly with real estate investors may have insight into a num­ber of deduc­tions most investors are unaware of. Terms like depre­ci­a­tion sched­ule, cost seg­re­ga­tions, car­ry for­ward basis, and oth­er strate­gic insight will serve investors well if their CPA is well versed. Over time the tax codes have changed, and it is a real chal­lenge for CPAs to keep their edge and be proac­tive on behalf of their clients. We have seen this first­hand when we speak at var­i­ous CPAs events and con­fer­ences.

Recent­ly we have pro­vid­ed, by request, a sem­i­nar for CPAs to under­stand the use of Delaware Statu­to­ry Trust (DST) as an invest­ment vehi­cle as well as replace­ment for a 1031 exchange.  

DSTs became an approved option in 2024 with what is known as a rev­enue rul­ing. Rev­enue rul­ing 2004-08 stat­ed that the DST struc­ture is legal­ly rec­og­nized as a method for investors to own real estate.  Since the 2004 Rev­enue Rul­ing (2004–86) a DST (Delaware Statu­to­ry Trust), became a legal­ly rec­og­nized vehi­cle for real estate invest­ment trusts to be estab­lished. This enables indi­vid­ual investors to own a ben­e­fi­cial inter­est (ref­er­enced as frac­tion­al inter­est) in real estate. The frac­tion­al inter­est is con­sid­ered a pas­sive invest­ment.

The rul­ing “con­clud­ed that [a Delaware Statu­to­ry Trust] is clas­si­fied, for fed­er­al tax pur­pos­es, as a part­ner­ship or a cor­po­ra­tion if the trustee has the pow­er to dis­pose of the prop­er­ty and acquire new prop­er­ty, rene­go­ti­ate or enter into leas­es, rene­go­ti­ate or refi­nance debt, invest cash to prof­it from mar­ket fluc­tu­a­tions, or make more than non-struc­tur­al mod­i­fi­ca­tions to the prop­er­ty. If, instead, the trustee’s activ­i­ties are lim­it­ed to the col­lec­tion and dis­tri­b­u­tion of income and the trust has a sin­gle class of inter­ests, then the trust is respect­ed as a trust. In such a case, inter­ests in the trust may be qual­i­fy­ing prop­er­ty in a tax-deferred like-kind exchange if the oth­er require­ments for such treat­ment are sat­is­fied.”

Is it the struc­ture or func­tion that Qual­i­fies as a DST?

There is more to a DST than the real estate. Almost all real estate can be set up and be held in a DST.  How­ev­er, it is the struc­ture that is impor­tant to qual­i­fy as a DST.

What is the struc­ture?

For all spon­sored DST there will be a Pri­vate Place­ment Mem­o­ran­dum (PPM).  There are many aspects of the legal doc­u­ments known as the PPM. DST is a secu­ri­ty and only avail­able to accred­it­ed investors. Advi­sors who work with investors need spe­cial licens­ing through FINRA or the SEC to review and rec­om­mend DSTs because these are secu­ri­tized real estate invest­ments. The PPMs (which are typ­i­cal­ly sev­er­al hun­dred pages long) pro­vide a wealth of infor­ma­tion regard­ing the offer­ing. There are also many dis­clo­sures with­in the PPM as well as infor­ma­tion on the man­age­ment team, local mar­ket analy­sis, spon­sor track record, and much more.

Non-recourse debt Maybe an investor’s best friend.

One of the require­ments of the 1031 exchange process is the require­ment to replace debt either with new debt or with fresh cash. This may become a stum­bling block for investors who wants to sell their prop­er­ty known as the relin­quished prop­er­ty (pay off the debt) may not be in a posi­tion to apply for an addi­tion­al mort­gage to sat­is­fy the IRS require­ments. The same investor may not want to invest fresh cash in the replace­ment prop­er­ty. The investor may be look­ing for an eas­i­er way to sat­is­fy the sec­tion 1031 require­ment to replace debt. Keep in mind that the investor must also have a replace­ment prop­er­ty of greater or equal val­ue to what they are sell­ing or relin­quish­ing. The stress of apply­ing for a new mort­gage with­in the 45-day iden­ti­fi­ca­tion. Cre­ates stress for the investor as the clock ticks on the 45 days to iden­ti­fy the prop­er­ty. If the investor is sell­ing a $2,000,000 prop­er­ty and has a debt of $500,000 (which would rep­re­sent a fair­ly low loan to val­ue ratio) the investor must still pro­ceed with apply­ing for a mort­gage to replace the debt or sim­ply bring an addi­tion­al $500,000 to the trans­ac­tion. Hav­ing the $500,000 addi­tion­al may be the issue. DST’s by design are prepack­aged with debt that enables investors to sat­is­fy the debt replace­ment. Each investor who acquires the DST with debt will be assigned a per­cent­age of the debt their equi­ty invest­ments. Non-recourse debt struc­tured in a DST enables the investor to sat­is­fy the require­ment of debt replace­ment on their pro rata share when they closed on the DST.

Time may just be on your side when invest­ing in DST.

Sec­tion 1031 of the Inter­nal Rev­enue Code requires investors to replace their relin­quished prop­er­ties with a like kind prop­er­ty. There are a vari­ety of asset class­es struc­tured as DSTS and do qual­i­fy as like kind prop­er­ty. In many ways DST’s being prepack­aged and vir­tu­al­ly sit­ting on the shelf makes for an easy selec­tion process in most cas­es. The deci­sion the investors need to make would be what type of asset they want to acquire and then what’s geo­graph­ic loca­tion they pre­fer. Some­one liv­ing in Illi­nois may want to select some­thing with­in the state of Illi­nois. Oth­ers may seek to diver­si­fy their real estate hold­ings and move to oth­er states. The prepack­aged nature of the DST enables the investor to close quick­ly on their replace­ment prop­er­ty so that their invest­ment dol­lars may be put to use soon­er rather than lat­er. There typ­i­cal­ly is no prob­lem with DST clos­ing well with­in the 180-day require­ment. We have writ­ten in our book case stud­ies of investors wait­ing to the end of their 45 daysto iden­ti­fy a DST and then being able to close on that same selec­tion of DSTs in as lit­tle as 5 days.

Vot­ing rights in the DST

When an investor tran­si­tions from tra­di­tion­al real estate to a DST one of the first hur­dles to over­come is not hav­ing any vot­ing rights. The spon­sor makes all the deci­sions on behalf of the investors. Many investors like this pas­sive approach to invest­ing.

DST and lia­bil­i­ties.

One of the rea­sons that DSC’s have become some­what more pop­u­lar than the ten­ants in com­mon has to do with the lim­it­ed lia­bil­i­ty that investors have in DST when com­pared to a ten­ant in com­mon­ly known as a TIC. The investor is only liable for the amount of cash or equi­ty that they’ve invest­ed in the DST. In the case of a TIC there would be addi­tion­al lia­bil­i­ty in most cas­es.

Tax ben­e­fits of the DST

In most real estate things investors enjoyed depre­ci­a­tion either res­i­den­tial or com­mer­cial over a num­ber of years. Investors can enjoy depre­ci­a­tion in the DST as well. CPAs are well versed or should be well versed in car­ry­ing for­ward depre­ci­a­tion from the relin­quished prop­er­ty into the replace­ment prop­er­ty. Each indi­vid­ual investor invest­ing in a DST will have a dif­fer­ent depre­ci­a­tion sched­ule based on investors cur­rent cost basis.

Real estate investors ben­e­fit from cost seg­re­ga­tion stud­ies

Not all DST’s and DST spon­sors will com­plete cost seg­re­ga­tion stud­ies on the under­ly­ing assets or prop­er­ty of the DST. It’s a lot of expense to cre­ate the cost seg­re­ga­tion study. If the spon­sor does per­form a cost seg­re­ga­tion study this may pro­vide addi­tion­al favor­able tax posi­tions and write offs for the investors.

Famil­iar forms for a CPA.

CPA’s typ­i­cal­ly have access to all of the fre­quent­ly used IRS required forms for indi­vid­ual tax­es. Like kind exchanges are report­ed on form 8824. This form will include the details of the exchange as well as the time­lines that the investors fol­lowed. The main items the IRS may be con­cerned with would be the same tax­pay­er ID used for the relin­quished prop­er­ty must be the same tax­pay­er ID for the replace­ment prop­er­ty. The oth­er items will be replac­ing the mar­ket val­ue as well as replac­ing any debt that was paid off with the relin­quished prop­er­ty.

Spon­sor report­ing to investors

On an annu­al basis spon­sors of DST have a respon­si­bil­i­ty of cre­at­ing and pro­duc­ing the nec­es­sary report­ing forms for DST own­er­ship in a time­ly man­ner. DST accord­ing to the IRS clas­si­fi­ca­tions are a form of direct own­er­ship of real estate. There are typ­i­cal­ly three dif­fer­ent types of reports that a spon­sor may pro­vide to an investor. The report may be a grant or let­ter, it may be a 1099 or it may be a K1. The infor­ma­tion pro­vid­ed by the spon­sors should pro­vide all the nec­es­sary income nec­es­sary infor­ma­tion for the CPA’s includ­ing deduc­tions income depre­ci­a­tion etcetera.

DST appeal

Accred­it­ed investors seek­ing insti­tu­tion­al qual­i­ty real estate as well as pas­sive man­age­ment and income may be well served to inves­ti­gate DST as a real estate option uti­liz­ing cash or a 1031 exchange.

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.