We continue our commitment to investor education. This post will focus on one of the primary reasons investors choose Delaware Statutory Trusts. Based on investor feedback it is their ability to qualify as replacement property in a 1031 exchange.
By Al DiNicola, AIF®
1031 Tax Deferred Exchange Specialists & DST Advisor
NAMCOA® – Naples Asset Management Company®, LLC
Securities offered through MSC-BD, LLC, Member of FINRA/SIPC
The Section 1031 Exchange Challenge
§1031 has been in place for over 100 years (with a few modifications from time to time). A 1031 exchange allows investors to defer capital gains taxes by reinvesting proceeds from the sale of real estate into “like-kind” property. However, investors must follow strict requirements. One of the more stressful tasks is to identify potential replacement properties within 45 days. These properties need to be submitted to and accepted by the qualified Intermediary (QI) who needs to be part of the exchange. Once the final list is submitted prior to end of the 45-day period no other properties may be identified. The next stressful task may be the ability to close on replacement properties within 180 days total time (135 days form end of 45-day period). Investors may be faced with arranging financing, performing inspections and other tasks to arrange a successful closing. The other requirements are financial. Investors need to replace both value and debt. In addition, use all the cash proceeds from the sale.
Time may not be on your side. Finding suitable properties under these strict timelines can be difficult. This may be stressful especially for investors exiting large or highly appreciated assets. In addition, the replacement of debt (or providing fresh cash) may complicate the exchange process especially if the investor needs to qualify for the replacement loan. We will review debt replacement in future posts.
IRS Approval of DSTs
It has been a little over 20 years since DST were approved. In Revenue Ruling 2004-86, the IRS ruled that a DST investor’s beneficial interest is treated as direct ownership of real estate. DST interests are not considered securities or partnership interests (Although DST require Regulation D (b or c) filing by the offering sponsor.DST properties qualify as like-kind real estate for §1031 and §1033 purposes.
This ruling opened the door for widespread DST usage in tax-deferred exchanges. However, DSTs are not recommended for all investors. DSTs are only offered to accredited investors. There are also suitability concerns that all DST advisors review with investors. Advisors who deal with DSTs as a normal course of business are best suited to assist investors.
Why DSTs Work So Well for Exchanges
DSTs offer several exchange-friendly advantages:
- Pre-packaged, institutional-quality properties. (We always monitor over 50-60 DSTs so that we are prepared to assist investors).
- Ability to invest any dollar amount, including leftover exchange funds. This may assist investors who need to replace remaining cash left over (referenced as boot) from a traditional exchange.
- No need to secure new financing (debt is assigned based on the DST Loan to Value (LTV) and as a percentage of the cash equity the investor acquires.
- Sponsor-arranged, non-recourse debt. The DST is the borrower.
- Faster closing compared to individual property purchases. DST may close in a matter of days, enabling investors to put investment dollars to use.
There are a few reasons why DSTs are especially valuable for investors. Investors may be concerned with failed exchange risk. This may be as a result of deadline pressure as well as difficulty replacing debt. There are also certain investors who at a certain age (or lifestyle) simply have a desire for passive ownership.
Common §1031 Use Cases
There are many uses for a DST being utilized in a 1031. The investor may be selling a rental portfolio and consolidating it into DSTs. At times investors may be seeking diversification and exchanging into multiple DSTs for diversification. The non-recourse debt may enable an investor to replace high leverage with lower risk structures.
DSTs provide a reliable, IRS-approved solution for completing complex §1031 exchanges.
As always contact us for more information and a complimentary consultation.
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.
Alternative investments and DSTs are not for all investors. The acquisition of a certain alternative investments including DSTs 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 §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, whether public or private, involves risk, including but not limited to the potential of losing some or all 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 company mailing address is 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, 97035MSC-BD, LLC and NAMCOA are independently owned and are not affiliated.
Thank you.
