After speaking with real estate attorneys, CPAs, and investment property real estate brokers on a daily basis, we have come to realize that the majority of these professionals are unaware of the 1031 Exchange utilizing the Delaware Statutory Trust (DST) as a potential option for their accredited investor clientele who are in need of replacement properties.
There are many investment property real estate owners that have held onto properties for decades and have realized large capital appreciation on their property assets. Unfortunately, many of the investors are at a point in their lives where they would like to sell their properties but are hesitant to do so because of the large capital gains tax they could be facing. Many of these investors are tired of what we call the three ‘T’s—toilets, tenants and trash!
Unbeknownst to them or their professional investment property advisors, is the 1031 exchange option utilizing the Delaware Statutory Trust (DST). In order for an investor to utilize the 1031 exchange into a single or multiple DST(s), an investor must be accredited. To be accredited means that, outside of their primary residence, they need to have a net worth in excess of $1million dollars or have income of at least $200,000 each year for the last two years (or $300,000 combined income if married) and have the expectation to make the same amount this year.
What Is a DST?
The DST is built by a sponsor, who is the trustee of the DST. Trustees are national real estate firms that buy properties in various sectors, such as: multifamily, student housing, net-lease etc., and structure the property as a security. These properties are offered to accredited investors through offering documents known as private placement memorandums (PPMs). The PPM’s give extremely detailed information on the property, or properties, in each DST explaining the risks, appraisals, environmental reports and third-party due diligence reports.
DSTs come in all shapes and sizes; some are all cash offering and some come with leverage that is arranged by the sponsor. Typically, we see the leveraged properties in the 50% LTV range, though some may go as high as 89%. The debt is held at the sponsor level and is non-recourse to the investors. This is important because if an investor has debt to replace on an exchange, they do not need to be underwritten and the debt won’t even show up on the investor’s credit report, yet the investor potentially receives all of benefits of the assumed debt.
In addition, if a client is all cash and chooses to exchange into a DST with leverage on it he could potentially realize tax-advantaged income. Keep in mind, though, that when the sponsor decides to sell the property he must exchange into a new property (if he chooses to do another exchange) with equal or greater debt on the new property.
Who Are DSTs Made For?
We would like to point out that DSTs may potentially be great tools for investors looking for 100% passive replacement, institutional-quality real estate. Many clients find themselves in a dilemma due to the short 45-calendar day identification period following the closing on their relinquished property.
THE INVESTOR MUST BE AWARE THAT THEY CAN NEVER TAKE CONSTRUCTIVE RECEIPT OF FUNDS ON THEIR RELINQUISHED PROPERTY AT CLOSING!! THE PROCEEDS MUST BE DEPOSITED WITH A QUALIFIED INTERMEDIARY WHO HOLDS THE PROCEEDS IN AN ESCROW ACCOUNT UNTIL THE INVESTOR HAS IDENTIFIED HIS PROPERTY, OR PROPERTIES, FOR REPLACEMENT WITHIN THE FIRST 45 CALENDAR DAYS. HE HAS 180 DAYS FROM HIS CLOSING DATE TO CLOSE ON THE NEW INVESTMENT PROPERTY(IES).
If the properties that the investor initially identified fall through after the 45th day, there are no exceptions and the investor will be forced to pay the capital gains tax.
- QUICK CLOSE—DSTs may be a good option because, if the DST or DSTs are identified prior to their closing, the investor will be able to close approximately a week after their funds are placed with the qualified intermediary
- BOOT ISSUES—DST’s may be great for BOOT issues. If a client sells a property for $10M and finds a property for $8M, a DST can fill the necessary $2M BOOT to help defer capital gains tax and complete their exchange fully
- BACKUP PROPERTY—DSTs may be a great option as a backup identification property. Suppose a client has his heart set on a certain property, but after he identified the property and is past his 45 identification window, the property falls through for some unforeseen reason. At this point he may fall back on the DST for replacement, as long as it is still available and he identified the DST within his 45-day window
Typically, while these number may fluctuate and cannot be guaranteed, DSTs today may offer 4.5% to 6.75% projected cash on equity invested—some lower, some higher.
Pros and Cons of Using a DST
As with all investments there are pros and cons, as well as inherent risks. For these reasons, one should consult with their Real Estate attorney, CPA and/or Registered Representative t see if a 1031 exchange using a DST is the appropriate avenue to explore.
The acquisition or sale of a Delaware Statutory Trust (DST) for the purpose of a tax-deferred 1031 exchange qualifies for treatment under section 1031 of the Internal Revenue Code ("1031 Exchange"). Investors will be able to sell the existing investment property or beneficial interest in a DST and complete a 1031 exchange into another "like-kind" investment property or beneficial interest in a new DST.
There are risks associated with investing in a Delaware Statutory Trust (DST) and real estate investment properties including, but not limited to, loss of the entire principal, declining market value, tenant vacancies and illiquidity. Any past performance or performance projections are not a guarantee of future results. Diversification is also not indicative of future results. DST 1031 properties are only available to accredited investors (generally described as having a net worth of over $1 million dollars exclusive of primary residence or $200,000 income individually/$300,000 jointly of the last three years) and accredited entities only.
The information herein has been prepared for educational purposes only, does not constitute an offer to purchase or sell securitized real estate investments, and is not meant to be interpreted as tax or legal advice. Because investors’ situations and objectives vary, this information is not intended to indicate suitability for any particular investor. Please speak with your legal and tax advisors for guidance regarding your particular situation.
Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Advisory services offered through Concorde Asset Management, LLC, an SEC registered investment adviser. Insurance offered through Concorde Insurance Agency, Inc. Fortitude Investment Group is independent of CIS, CAM and CIA.