Investors Prepare for End of the Year Potential Portfolio Balancing

Each year as investors move into the fourth quar­ter there’s always antic­i­pa­tion and appre­hen­sion about mak­ing moves to port­fo­lios that investors have dealt with all year. The end of the year bal­anc­ing act always brings a lit­tle ner­vous­ness regard­ing mak­ing the right moves.

Octo­ber 1, 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

Investors who own real estate and active­ly man­age that real estate may be look­ing for­ward to mov­ing out of active man­age­ment and into pas­sive man­age­ment of real estate. At the same time investors may be seek­ing tax advan­tage pro­grams to defer cap­i­tal gains on appre­ci­at­ed real estate and oth­er assets. Many real estate investors real­ize that own­ing real prop­er­ty can be very reward­ing and the tax ben­e­fits may be the dri­ving force behind own­ing the real estate. How­ev­er, man­ag­ing these prop­er­ties espe­cial­ly when the prop­er­ties are aging and may need cap­i­tal infu­sion for repairs and even main­te­nance, the high reward may also come with high risk.

Over the last 20 years Delaware Statu­to­ry Trusts have offered an effi­cient solu­tion to real estate investors seek­ing to release the bur­den of man­ag­ing and own­ing indi­vid­ual real estate assets. The oth­er advan­tage of Delaware Statu­to­ry Trusts includes the abil­i­ty for the investors to diver­si­fy either geo­graph­i­cal­ly or by asset class. Diver­si­fi­ca­tion does not elim­i­nate risk to the investor, but it may help in min­i­miz­ing risk.

As a quick review, a Delaware statu­to­ry trust (or a DST) is an enti­ty that was formed in the state of Delaware. The enti­ty pro­vides some flex­i­bil­i­ty in its legal struc­ture. You may hear the word frac­tion­al own­er­ship or frac­tion­al inter­est in real estate and that has long been asso­ci­at­ed with ten­ants in com­mon or TIC. The DST enables indi­vid­ual investors to par­tic­i­pate in an invest­ment struc­ture with large insti­tu­tion­al size real estate prop­er­ties. DSTs offer some flex­i­bil­i­ty (with some restric­tions) when com­pared to a TIC. The real estate prop­er­ties offer pas­sive man­age­ment for the investors mean­ing a hands-off approach to the man­age­ment of the real estate. There are indi­vid­ual investors who enjoy the active day-to-day man­age­ment and coor­di­na­tion of the real estate assets that they own. Own­er­ship of a DST is not for these types of investors.

Investor Inter­est. Recent­ly we’re con­tact­ed by an investor over the age of 85 you were seek­ing to do a §1031 tax deferred exchange and move into a DST. The prop­er­ty that he was sell­ing was one that was owned by the investor for over 40 years. Con­trast that type of investor to an investor who over 40 years may have exe­cut­ed five and poten­tial­ly more §1031 exchanges mov­ing in and out of dif­fer­ent real estate hold­ings. What was impor­tant for the 85-year-old investor was not so much the cash flow that would be thrown off but the safe­ty of the replace­ment assets and the defer­ral of cap­i­tal gains on his appre­ci­at­ed assets. The elder­ly investor also under­stood at some point in time the replace­ment assets would expe­ri­ence a step up in bases that his heirs would enjoy.

In the exam­ple above the elder­ly investor had a prop­er­ty that was sell­ing for more than $1,000,000 and there was no debt on the prop­er­ty. The real estate was acquired orig­i­nal­ly for $225,000. The §1031 exchange enabled the investor to defer the cap­i­tal gains on the prop­er­ty as well as defer the recap­ture of depre­ci­a­tion of the prop­er­ty tak­en over the hold­ing peri­od. The Delaware Statu­to­ry Trust enabled the investor to move into four dif­fer­ent DSTs that rep­re­sent­ed a full replace­ment of the pro­ceeds from the sale. This par­tic­u­lar investor was also seek­ing to increase poten­tial real estate deduc­tions through tak­ing on what’s known as non-recourse debt in the DST struc­ture. Own­ing the prop­er­ty for 40 years com­plete­ly exhaust­ed any of the depre­ci­a­tion the investor was uti­liz­ing as poten­tial deduc­tions on his tax­es. The investor was open to tak­ing on prop­er­ties with a more con­ser­v­a­tive loan to val­ue or LTV under 50% loan to val­ue. As an aside many DSTs are struc­tured with cer­tain lev­els of debt in order to sat­is­fy the require­ments of the §1031 exchange of replac­ing debt in the exchange. There are also all cash DST (absence of debt) that some investors pre­fer. There are advan­tages and dis­ad­van­tages to each posi­tion.

Port­fo­lio con­struc­tion. The instruc­tions from the accred­it­ed investor were to seek out real estate prop­er­ties in the indus­tri­al asset class and self-stor­age asset class. In addi­tion, the investor pre­ferred to move into states with­out a state income tax. The investors’ con­cern focused more on not hav­ing to file a state income tax return as com­pared to the income tax that they may pay to the indi­vid­ual states. The investor focused on a self-stor­age facil­i­ty in Texas that con­sist­ed of three dif­fer­ent self-stor­age loca­tions. In addi­tion, there were two indus­tri­al type prop­er­ties in Flori­da that sat­is­fied the investors goals.

Urgency to Iden­ti­fy. The investor appre­ci­ates the abil­i­ty of the finan­cial advi­sor to focus on meet­ing his needs with­in the 45-day iden­ti­fi­ca­tion require­ment stip­u­lat­ed in the §1031 exchange process. DSTs are prepack­aged and struc­tured that enables finan­cial advi­sors once they com­plete suit­abil­i­ty align­ment with the investor to pro­posed alter­na­tives for the investors to select. As finan­cial advi­sors we seek to con­duct due dili­gence on DST offered by spon­sors so that at any giv­en time we are aware of the avail­abil­i­ty of cer­tain assets. Then when investors con­tact us, we review investor suit­abil­i­ty require­ments and make rec­om­men­da­tions.

Final Thoughts: DSTs are not for every­one, how­ev­er there are cer­tain advan­tages investors have real­ized over the past 20 years. §1031 exchanges have near­ly seam­less inte­gra­tion with DST’s. Qual­i­fied inter­me­di­aries have become more aware of the DST alter­na­tive. The abil­i­ty to diver­si­fy your port­fo­lio has also become one of the dri­ving forces using mul­ti­ple DST’s when replac­ing one prop­er­ty. DSTs are pro­fes­sion­al­ly man­aged which enables the investors to enjoy pas­sive own­er­ship of the real estate.

Do Not Pan­ic: if you are read­ing this arti­cle and are attempt­ing to decide whether to sell your invest­ment prop­er­ty in the 4^th quar­ter and uti­lize a §1031 exchange, we may be in a posi­tion to help. In addi­tion, if you are already inside your 45-day peri­od and have become frus­trat­ed with the inabil­i­ty to locate suit­able replace­ment prop­er­ties we can def­i­nite­ly help.

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. 

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