DST 1031 Exchanges
October 31, 2018
Scottsdale Wealth Planning
In the course of my business working with high-net-worth families, I have been exploring solutions for clients who are planning to sell their commercial or investment real estate property, often in preparation for retirement, including 1031 exchanges and DST 1031 exchanges.
Real estate professionals may already be familiar with the 1031 exchange (ref. Section 1031 of the Internal Revenue Code), whereby an owner exchanges real property for like-kind real estate (including business and investment property, but not the owner’s primary residence), deferring any capital gains that may arise from the sale. It is important to note that there are several specific guidelines that must be followed in order to successfully execute a 1031 exchange transaction. For instance, the cash invested in the replacement property must be equal to or greater than the cash received from the sale of the relinquished property, and debt on the replacement property must be equal to or greater than the debt on the relinquished property. Additionally, properties must be identified within 45 days and the transaction must be completed within 180 days of the initial sale. Prospective investors should consult a tax advisor regarding a 1031 exchange.
A Delaware statutory trust (DST) permits fractional ownership in which multiple accredited investors can share ownership in a single property or a portfolio of properties, which qualifies as replacement property as part of an investor’s 1031 exchange transaction. An exchanger sells property and proceeds are escrowed with a qualified intermediary (QI), a company that facilitates Section 1031 tax-deferred exchanges. The QI enters into a written agreement with the investor in which the QI transfers the relinquished property to the buyer while transferring the replacement property to the investor pursuant to the exchange agreement. The QI holds the proceeds from the sale of the relinquished property in a trust or escrow account in order to ensure the investor never has actual or constructive receipt of the sale proceeds, which would trigger capital gains consequences. The investor receives a beneficial interest in a DST, assuming no management responsibilities.
From an investment-oriented standpoint, DSTs offer interesting benefits, including access to institutional-quality properties that most real estate investors can’t afford to own, allowing investors to acquire partial ownership of properties that otherwise would be out of reach. Investors can divide their investment among multiple DSTs, which may provide for a more diversified real estate portfolio across geography and property types. For estate planning purposes, all 1031 exchange investments receive a step up in cost basis upon death so one’s heirs will not inherit capital gains liabilities. A 1031 exchange investment also provides heirs with professional real estate management versus the burden of hands-on management.
If you are considering a 1031 exchange for your business or investment real property, a DST 1031 exchange may be a more suitable, flexible alternative to directly holding an investment property.
This is a brief and general description of certain 1031 guidelines that is not meant to include all relevant provisions of a 1031 exchange. Prospective investors should consult with their own tax advisors regarding a 1031 exchange.