Challenges in Balancing the Equity and Debt in a §1031 Exchange ~ Part 2 Back Stage

Bal­anc­ing larg­er exchanges requires an in-depth analy­sis of the investor’s goals and the §1031 require­ments for equi­ty and debt replace­ment. Not all exchanges (uti­liz­ing a Delaware Statu­to­ry Trust, DST) are the same.

April 21, 2025

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

In Part 1 we high­light­ed the com­po­nents of the exchange uti­liz­ing the equi­ty and debt replace­ment.  Some investors are curi­ous how we are able to sat­is­fy the exchange com­po­nents (with what seems like ease) for their spe­cif­ic exchange.  As men­tioned in Part 1 the com­po­nents of the exchange may rep­re­sent parts on the Jen­ga game. Chal­lenges Part 1 Cen­ter Stages You may have played Jen­ga in a fam­i­ly set­ting. This block-bal­anc­ing game may become com­pet­i­tive as you attempt to remove and replace blocks to build a tow­er.  With larg­er exchanges (even $1,000,000) that include debt, the bal­anc­ing becomes more involved. We have devel­oped a matrix that com­pares many DST offer­ings in sev­er­al key areas.  At any giv­en time, there may be over 70 offer­ings. Dur­ing the process our engage­ment with investors may involve remov­ing and adding DST replace­ment prop­er­ties and rebal­anc­ing the exchange.

The matrix we have cre­at­ed enables us to facil­i­tate investors (cash or §1031) seek­ing to uti­lize the pas­sive ben­e­fits of a DST. There are sev­er­al steps or items that we track.

Total DST options vs all cash options. This may be the start­ing point for investors who absolute­ly need debt to sat­is­fy their exchange or §1031 investors seek­ing to pick up debt to increase poten­tial tax advan­tages.  Cur­rent­ly of the 71 DSTs we are track­ing, 26 are all cash DSTs.

Type of DST offer­ing.  All DSTs require accred­it­ed investor sta­tus, and the offer­ings may be a 506 (b) offer­ing or a 506 © offer­ing.  The dif­fer­ence is whether the advi­sor has an exist­ing rela­tion­ship with an investor 506 (b) or adver­tis­ing could be involved 506 ©.  The indus­try spon­sors are split on this reg­is­tra­tion with 33 being the (b) offer­ing and 37 being the © offer­ing. To see 506 © offer­ings vis­it here. Exam­ple of Cur­rent Inven­to­ry

Exit Options: There may be a vari­ety of exit strate­gies that are list­ed in the pri­vate place­ment mem­o­ran­dum or PPM. There is the tra­di­tion­al exit strat­e­gy for DST which may be to have the sales pro­ceeds returned to the investors trig­ger­ing a cap­i­tal gains event. The oth­er exit may be exe­cut­ing a §1031 exchange uti­liz­ing a new DST or exe­cute a §1031 exchange back into tra­di­tion­al real estate. An option, which came out a few years ago, would be a poten­tial 721 UPREIT as an option­al strat­e­gy for the investor. Spon­sors may or may not be ver­ti­cal­ly inte­grat­ed with their own REIT option. But sure­ly this may pro­vide addi­tion­al flex­i­bil­i­ty for cer­tain investors. There is also a new­er option with a 721 manda­to­ry UPREIT. This is typ­i­cal­ly offered by large real estate spon­sors who are ver­ti­cal­ly inte­grat­ed with access to either a pri­vate non­trad­ed REIT or a Pub­licly trad­ed REIT. See our past arti­cle on REITs here. Div­ing into Non­trad­ed REIT Struc­tures

Asset Class: The next area that is part of our matrix is sim­ply to iden­ti­fy the asset class. Asset class­es could fall into dif­fer­ent cat­e­gories, such as mul­ti­fam­i­ly, indus­tri­al, nec­es­sary retail, self-stor­age, Life Sci­ence and a few oth­ers. Some offer­ings may even com­bine more than one asset class. There may be a mixed-use oppor­tu­ni­ty which could include retail, mul­ti­fam­i­ly or oth­er types of triple net lease oppor­tu­ni­ties. Investors may be very spe­cif­ic as to the asset class or geo­graph­ic loca­tion.

Cur­rent Avail­able Equi­ty: Remain­ing equi­ty that’s avail­able for investors may be elu­sive at times. Small­er offer­ings (under a $15M or $20M) may not stay on the mar­ket for a long peri­od of time. We track on a week­ly basis the remain­ing equi­ty in the oppor­tu­ni­ties so that when we do receive a call from an investor, we know approx­i­mate­ly how much is avail­able. We pro­vide a land­scape overview on our web­site. DST Land­scape Sum­ma­ry

Pro­ject­ed Returns: One of the next items is for ref­er­ence, and that would be the ini­tial pro­ject­ed annu­al returns on each of the DST offer­ings. This enables us to cal­cu­late indi­vid­u­al­ly and cumu­la­tive­ly, across all poten­tial selec­tions, the amount of income that a poten­tial investor may be able to real­ize from their invest­ments.

Poten­tial Equi­ty Invest­ed: Here is where we start the process for indi­vid­ual investors. With the investors we deter­mine the amount of poten­tial equi­ty that may be invest­ed in any par­tic­u­lar asset or mul­ti­ple assets. When investors uti­lize mul­ti­ple assets, we have a func­tion which will show us the total amount of cash pro­ject­ed to be invest­ed in all of the DSTs poten­tial­ly select­ed. This helps us to ensure all the cash com­ing out of the §1031 exchange pro­ceeds are used.

Debt or LTV: Very impor­tant ele­ment that we tracked across all of our offer­ings that we have on our matrix is the debt or lever­age per­cent­age. We need to know if it’s an all cash deal offer­ing with no lever­age, which means 100% equi­ty ver­sus an offer­ing that could be offer­ing non-recourse debt. The debt can range as low as some­where in the 15 or 20% range up to a high of 85%. The more lever­aged DST’s, over 80% for exam­ple, are struc­tured specif­i­cal­ly to han­dle require­ments for investors that have a high LTV to sat­is­fy or alter­na­tive­ly oth­er tax effi­cient pro­grams.

Total Replace­ment Val­ue: Total pur­chase price is dis­played across all of the poten­tial invest­ments as well as what the new debt assign­ment would be, based on the LTV of each indi­vid­ual invest­ment. There’s also an annu­al pro­ject­ed cash flow.

Over­all Spon­sor Equi­ty: We also track the total spon­sor equi­ty offer­ings, total spon­sor equi­ty per­cent­age, the sponsor’s debt, and the per­cent­age of sponsor’s debt. We also track the total of the over­all offer­ing.

Indi­vid­ual Investor Equi­ty per­cent­age: We track the indi­vid­ual investors’ equi­ty. The indi­vid­ual investor’s debt and the per­cent­age of own­er­ship of that indi­vid­ual asset. This enables us to ful­fill poten­tial qual­i­fied inter­me­di­ary require­ments to demon­strate the per­cent­age of own­er­ship on a par­tic­u­lar asset if they’re not acquir­ing 100% of an asset. This per­cent­age of own­er­ship will also show up on the spon­sor of the DSTs clos­ing state­ment when com­plet­ing the §1031 exchange.

Back Stage: Work­ing with each indi­vid­ual investor to deter­mine inter­est, suit­abil­i­ty and asset class inter­est, we select the appro­pri­ate poten­tial replace­ment prop­er­ties. If the investor has a small­er exchange (under $500,000 for exam­ple), there may be one or two replace­ment prop­er­ties select­ed.  Under­stand­ing the replace­ment rules for the 1031 exchange enables us to iden­ti­fy poten­tial replace­ment prop­er­ties.  Typ­i­cal­ly, we uti­lize the three-prop­er­ty rule or the 200% rule. (The 95% rule is sel­dom used).

The matrix we have cre­at­ed will cal­cu­late the over­all Tar­get Replace­ment Val­ue, the Tar­get Required Cash to be used and if required Tar­get Debt Replace­ment Val­ue.  This enables us to offer alter­na­tives for pri­ma­ry focus or back-up to tra­di­tion­al 1031 exchanges.

One of the case stud­ies we have writ­ten about was the abil­i­ty to assist an investor who was run­ning out of time (45-day iden­ti­fi­ca­tion peri­od) and could not locate replace­ment prop­er­ties. We helped iden­ti­fy a total of 13 prop­er­ties, all under the 200% rule. There were 7 prop­er­ties even­tu­al­ly select­ed that bal­anced a replace­ment val­ue of over $6M that includ­ed $2.5M in debt.

If you are won­der­ing how to bal­ance the exchange and ful­ly explore your options, please get in con­tact with us.

NAMCOA® is a SEC reg­is­tered invest­ment advi­so­ry firm that pro­vides com­pre­hen­sive port­fo­lio man­age­ment, finan­cial plan­ning, and fidu­cia­ry deci­sion-mak­ing ser­vices on behalf of retire­ment plan spon­sors. Our Dif­fer­ence is sum­ma­rized by our fidu­cia­ry approach which enables us to bet­ter meet port­fo­lio and retire­ment plan objec­tives, result­ing in stronger risk adjust­ed returns for investors and peace of mind for Clients. We also focus on alter­na­tive real estate invest­ment. Many real estate investors are seek­ing tax deferred solu­tions uti­liz­ing §1031 exchanges or Oppor­tu­ni­ty Zones.

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 §1031 Tax 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. 5 Cen­ter­pointe Dri­ve, Ste. 400 Lake Oswego, OR, 97035. MSC-BD, LLC and NAMCOA are inde­pen­dent­ly owned and are not affil­i­at­ed.

Thank you.