Here is an all-too-common occurrence today: Investment property owners who have been sitting on large real estate gains imbedded within their properties are now receiving attractive offers from potential buyers. The dilemma for these owners, however, is whether to sell and potentially incur the sizable tax on their gains or to consider a 1031 Exchange into another like-kind property.
I come from a family that has owned and still owns multifamily assets. I’ve seen first-hand the financial benefits of these types of business investments and I’ve also witnessed the hassles of managing and maintaining investment properties.
One segment of current interest to real estate investors are the gentrified areas of major cities such like the boroughs of New York City. Property values in these locations are often experiencing growth greater than other areas. Many of the investors we speak to every day who own properties in these areas where values have appreciated significantly, are compelled to accept their dream offers!
But, many of these same investors also have reservations about exchanging into replacement properties (via a 1031 Exchange) that they know little about. As current owners, they are quite familiar with the issues related to their own properties and they often express concerns to us about simply exchanging their current headaches for new ones.
In addition, many of these real estate owners are aging and are simply tired of managing real estate properties. They would like to continue owning income-producing property and are intent on avoiding the taxable gains they would be saddled with if they simply sold and cashed-out. On the other hand, they are motivated to accept the attractive offers they are receiving and looking to sell.
Fortunately, there is a type of 1031 Exchange vehicle called a Delaware Statutory Trust (DST) that can satisfy both their desires and concerns. There are compelling reasons why DST’s are of interest to aging real estate investors who are tired of managing real estate and are dealing with the three ‘T’s’ (commonly known as toilets, tenants, and trash).
Before I lie out my case why a DST might be well worth your consideration, as well as identify several of the rules around DST’s (which I’ll cover in a future blog post), it’s important to know who qualifies for this type of investment. In order to use a DST as a replacement property or properties, and become a 100% passive investor in institutional quality real estate, in virtually any real estate sector in the U.S., you must be an “Accredited Investor” which is defined as follows:
One must have a net worth of at least $1,000,000, excluding the value of one's primary residence, or have an 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. The term "Accredited Investor" is defined in Rule 501 of Regulation D of the U.S. Securities and Exchange Commission (SEC) as:
- A bank, insurance company, registered investment company, business development company, or small business investment company;
- An employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million;
- A charitable organization, corporation, or partnership with assets exceeding $5 million;
- A director, executive officer, or general partner of the company selling the securities;
- A business in which all the equity owners are accredited investors;
- A natural person who has individual net worth, or joint net worth with the person's spouse, that exceeds $1 million at the time of the purchase, or has assets under management of $1 million or above, excluding the value of the individual's primary residence;
- A natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year; or
- A trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes."
In the next post, we’ll look more closely at how DST’s work, as well as many of the advantages they can potentially offer.
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