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Utilizing DSTs in a 1031 Exchange

Ok landlords, we have given you lots of compelling reasons for exchanging out of your left coast properties for a more user-friendly environment in the sunbelt/red states.  However, you may be asking yourself how does this all work?  Here goes.

We all know that Section 1031 of the Internal Revenue Code provides real estate owners with an effective strategy for deferring capital gains tax that may arise form the sale of business or investment real property.  If you are at that point in the ownership cycle where you absolutely positively don’t want to manage anymore then the partial ownership structure DST provides may be a viable option if suitable.  You go from owning 100% of a much smaller asset to a fractional interest of a much larger asset or group of assets.  This brings with it the cessation of all management responsibilities.  The DST itself is the single owner and agile decision maker on behalf of investors.

Furthermore, most individual real estate investors can’t afford to own multi-million-dollar commercial properties.  Heretofore, this has been the exclusive purview of institutional investors.  DSTs allow retail investors to acquire ownership in properties that would otherwise be out of reach.

Also, the loans that encumber many of these properties are nonrecourse to the investor.  The DST itself is the sole borrower.  Investors need not qualify for anything.  As such, you receive the benefits of leverage:  enhanced cash flow potential, interest expense deduction and exchange mandated debt replacement.  No personal guarantee required here.

The DST structure also provides folks in 1031 exchange with low investment minimums.  In turn, this enhances your ability to diversify across different property types and geography.  You can slice and dice your exchange equity among as many different DST properties as you like.

In my opinion the diversification unique to DSTs is the principal advantage to real estate investors at this point in the asset price cycle (top).  After nearly a decade of zero interest rates and global quantitative easing, the world is awash in money.  There is more cash than there are good places to put it.  Therefore, I believe a defense against overpaying for a single asset on the up leg of your exchange is to diversify over as many different assets as possible.

This is difficult for investors to do by themselves.  The three-property rule, 90% rule or 200% rule are limiting or cumbersome at best.  The coordination and timing required here to close on multiple properties is daunting.  As such, the risk to your exchange is significant.

With DST all this has been done for you.  All you really need do is mix and match those properties you are most comfortable with in those locations which are most desirable. 

DST properties will also provide your heirs with a stepped-up cost basis.  Therefore, your capital gains tax liability passes with you.  And if, as is so often the case, your heirs have had little or nothing to do with your real estate portfolio, DSTs will provide them with an in-place professional real estate management team vs. the burden of assuming this responsibility themselves.

What could be better?

Disclaimer:

This material and views are prepared solely by the author and does not necessarily represent the views of the its affiliates. Statements concerning financial market trends are based on current market trend, which will fluctuate. Projections are inherently limited and should not be relied upon as an indicator of future results. Historical figures and performance are not indicative of future results. This is for informational purposes only and does not constitute an offer to buy or sell any investment.

DST 1031 properties are only available to accredited investors (typically have a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last three years) and accredited entities only. There are risks associated with investing in Delaware Statutory Trust (DST) and real estate investment properties including, but not limited to, loss of entire principal, declining market value, tenant vacancies and illiquidity. Diversification does not guarantee profits or guarantee protection against losses. Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated.

Because investors situations and objectives vary this information is not intended to indicate suitability for any particular investor. This information is not meant to be interpreted as tax or legal advice.  

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