Real estate investment presents unique opportunities and challenges, especially in the context of retirement and estate planning. The Baby Boomer (1946-1964) and Silent Generation (1928-1945) cohorts are solidly in these stages of life. They face crucial tax, estate, and financial planning decisions that can have an outsized impact on quality of life and family legacy. Many have spent decades amassing wealth through business, real estate, or strategic investment. For these investors, it is essential to incorporate effective tax and estate planning tools or risk unnecessary taxation undoing years or decades of wealth accumulation. To address this, strategies such as the 1031 Exchange, Delaware Statutory Trust (DST) & 721 UPREIT are growing in popularity.

The 1031 Exchange

The 1031 exchange has allowed investment real estate owners to defer capital gains and recapture tax dating back to the 1920’s. Imagine property sold for $10,000,000 with a near zero cost basis. Without using a 1031 exchange, a seller may owe capital gains tax (as much as 20%), depreciation recapture tax (as much as 25%), Net Investment Income Tax (3.8%), and state taxes (as much as 13.3%) on the proceeds from the sale. This could result in many millions in tax liability. Fortunately, the 1031 exchange, in combination with other tax and estate strategies, can help exchangers defer the full amount of these taxes while preserving and growing their wealth for future generations to enjoy.

The Cruise Ship of Real Estate Ownership - The DST for Passive Investment 

A Delaware Statutory Trust (DST) is a legal entity that allows real estate investors and 1031 exchangers to own a fractional interest in institutional-quality properties. These are commercial real estate assets that are managed and operated by reputable, billion-dollar investment companies for the benefit of their 1031 exchange investors. While Dad or Grandad preferred to be the Captain his own ship, building wealth through hands on management of his real estate or business, the next generation may prefer to kick their feet up on the proverbial “cruise ship of real estate,” not dealing with the headaches of tenants, maintenance, and management. This can be equally beneficial to those seeking to enjoy their golden years and make the transition from active property management to passive income.

Potential Benefits of DSTs

• Passive Ownership: Enjoy real estate benefits without the headaches of management.
• Diversification: Mitigate risk by selling one asset and exchanging into a portfolio diversified across asset class, strategy, geography, and risk. 
• Non-Recourse Debt: Replacing debt in your 1031 with non-recourse debt in the DST and protect your personal assets.
• Swap Til You Drop: 1031 exchange and defer your tax liability when each DST sells. Set up your heirs to inherit and take advantage of a step up in cost basis.

A 1031 Exchange Alternative – 1031/DST with the 721 UPREIT

Similar to Section 1031, IRC Section 721 allows for a tax deferred exchange of property. Instead of a sale and reinvestment, the 721 allows for tax-deferral on the contribution of property to a partnership. The contributed property can be cash, real estate, or securities. In exchange, the contributing party receives ownership interests in the partnership itself. Like the DST, this can be a useful tool for estate planning.

In this scenario, a client sells their property and performs a 1031 exchange. In their exchange, they purchase a DST that features a 721 UPREIT option. After an appropriate time period (usually 2-4 years) the DST is acquired by a predetermined REIT and clients trade their DST ownership through the 721 Exchange for shares of a REIT. This provides exposure and ownership to a larger portfolio of properties. 

Potential Benefits of 721 UPREITs

• Liquidity: Redeem or sell REIT units on the stock exchange to cover medical costs, spontaneous expenses, or to treat the grandkids.
• Diversification: The 721 UPREIT’s my own hundreds of properties across many markets.
• Tax Deferral: Defer capital gains taxes through the 1031/721 while selling your property. 
• Estate Planning with Multiple Heirs: Simplify the transfer of wealth to multiple heirs with easily divisible liquid REIT shares, vs. inheritance of direct property.
• Stepped Up Cost Basis: REIT shares receive a step up in cost basis just like real estate. Heirs can immediately liquidate without worrying about deferred gain or recapture.

It’s Never Too Early For Planning

Effective estate planning for real estate investors requires navigating complex tax scenarios and strategic investing to secure the future of your wealth and your legacy. Implementing strategies like the Delaware Statutory Trust, 721 UPREIT, and other passive investment options may help you achieve these goals.

Tommy Thompson and Justin Kiehne manage the Palm Beach office of Fortitude Investment Group, a national leader in the 1031 Exchange, DST, and 721 UPREIT industry for more than 20 years. The Fortitude team holds the record for the largest ever 1031/DST transaction, a $176,000,000 portfolio sale and exchange.