Top 5 Reasons DSTs Can Help Your Clients That Own Investment Real Estate (10 Min. Read)

Whether you are a CPA, Financial Advisor or Real Estate Agent, chances are you have clients and/or prospects that own Investment Real Estate. If they are interested in selling or exiting, you may be able to offer incredible value through tax deferral strategies utilizing a §1031 Exchange. Perhaps the prospect or client is hesitant to sell and lock in a large capital gain for fear of being hit with a large tax bill – providing a solution to minimize this tax burden can help them take advantage of the next investment opportunity and compound their wealth accumulation in the process. For Real Estate Agents, this is a powerful tool to assist in getting investors off the sidelines. 

However, despite the enormous benefits this strategy can provide, few investors and professionals seek to actually implement a §1031 Exchange in practice. This can largely be attributed to the complexity and plethora of requirements and intricacies surrounding traditional §1031 Exchange transactions, as well as an overall lack of resources, support, and expertise needed to guide them through the process (let alone know where to get started). Further, the vast majority of professionals with only a surface level understanding of how to implement this strategy may think that to qualify as a “like-kind” exchange they are limited to purchasing more direct real estate, which in and of itself is a time consuming and stressful process without layering a §1031 Exchange strategy on top of it. Many do not realize that an investment in a fractional interest of real estate, known as a Delaware Statutory Trust (DST), qualifies as “like-kind” property and provides an effective solution for simplifying the §1031 Exchange process while simultaneously providing the investor with a more steady, consistent, and passive income stream than traditional real estate. 

Being well-versed in the advantages of complex tax deferral strategies surrounding real estate and how Delaware Statutory Trusts (DSTs) can be utilized in conjunction with a §1031 Exchange will not only benefit your investor clients but will ensure you stand out as THE Trusted Advisor amongst a sea of financial professionals. Here’s our Shortlist of benefits DSTs can offer to supercharge your client’s §1031 Exchange: 

1. Satisfy IRC §1031 Exchange Hurdles

Like-Kind Qualified – Rul. 2004-86 published under Internal Revenue Bulletin: 2004-33 established that DSTs are considered a fractional interest of real estate qualifying as “Like Kind” replacement property eligible for capital gain tax deferral treatment under IRC §1031. Note that DSTs must meet certain requirements to qualify as a direct interest in real estate.  

Replacement Property Backup – Investors wishing to execute a §1031 Exchange will be required to identify the replacement property within 45 days of selling their relinquished property (most often utilizing the “3 Property Rule”). Rather than selecting just one potential replacement property and risking a busted exchange if the deal falls through between the 45-day and 180-day window, an investor can identify property owned by a DST as a precautionary backup property, creating a fallback plan in the event the primary property deal falls through. 

Quick Closing Turnaround – Typical real estate transactions can be a lengthy process, often spanning several months. Any delays encountered during the offer, acceptance, appraisal, inspection, and other due diligence phases leading up to and including the closing process might threaten the 180-day window to close on the replacement property. DST investments have a closing and escrow process that may take as little as 1-3 days, helping ensure you complete the exchange on time.

2. Diversify & Upgrade 

Institutional Grade Portfolio – DSTs allow investors to have fractional ownership in a larger pooled capital real estate investment. This may be a portfolio of several properties or a singular large institutional grade property typically not accessible to individual retail investors due to lack of sufficient capital. Either way, the investor can “trade-up” the quality of their real estate holdings without needing the substantial capital typically required for this type of portfolio.

Flexibility in Diversification – DSTs offer incredible flexibility in allowing investors to diversify from a singular or handful of property(s) to multiple properties. An investor could invest in one (1) DST that owns several properties across numerous geographic locations, asset classes, tenant demographics, or industries or split proceeds among several DSTs that each focus on different category or demographics of institutional grade/commercial properties.

Low Minimum Investment – As fractional interests, DSTs allow investors to access this diversification of real estate holdings and institutional grade investment opportunities with as little as $100,000 in some cases.

3. Passive Income from a truly Passive Investment

No More Property Management – Properties owned by DSTs are professionally managed by a third-party management company. Professional Property Managers not only relieve the burden and headache associated with handling the 3 T’s (Tenants, Toilets & Trash), but also have the size, scale, and experience to manage properties far more efficiently and cost effectively than most individual investors.

Consistent Cash Flow – Not only is the investment income passive, the portfolio diversification across several properties and access to better quality institutional grade properties with safe and secure tenants means more steady and consistent monthly income streams – all with less risk of vacancies. Steady cash flow from DSTs typically average ~5% – 7%.

Experienced Professionals – DST Sponsors have the resources and expertise from a team of experienced real estate professionals that are able to perform significant due diligence and access appraisals, property reports, environmental reports, and market data and analyses necessary to ensure its properties are sound investments.

4. Limit Liability

Limited Personal Liability – A DST is a vehicle that operates as a Trust rather than a de facto partnership. This means the DST provides a similar corporate veil and shelter from liability as Limited Liability Company (LLC) protection. Investors that own investment real estate personally may be subject to substantial personal liability.

Non-recourse financing – Since the DST is the ultimate borrower of any funds, investors are not subject to any personal liability or lender recourse on property leverage. In a §1031 Exchange, the debt on replacement property must equal or exceed the existing debt on the relinquished property. Any shortfall in debt is considered taxable “boot” to the exchanger. DSTs can allow investors to meet this debt requirement without taking on any new personally guaranteed debt. If their existing investment property is owned free-and clear, they could take advantage of non-leverage DSTs, or choose to utilize leveraged DSTs to significantly enhance their returns compared to existing income streams.

5. Wealth Transfer

Continuous Deferral of Tax – DST investments typically have a hold period of 5 – 7 years before the Sponsor will exit their property holdings and return capital to the investors. At this point, investors can reinvest in another DST investment, effectively continuing to defer the capital gain tax burden. The investor can continue to exchange their DST investments until their death.

Step up in Basis – Under current tax laws, upon death of the investor, any heirs or beneficiaries will receive a “Step Up” in tax basis in the investment when bequeathed, effectively eliminating the capital gains taxes on the original property (and all subsequent exchanged properties).

Flexibility in Planning – DSTs offer a unique opportunity to eliminate any dispute among inheriting heirs or beneficiaries. When the investor passes, the heirs continue receiving any distributions from the investment, and upon liquidation of the DST by the Sponsor each heir can determine what they prefer to do with their portion – either continue exchanging into future DSTs, or alternatively exit with their portion and receive cash proceeds.

Completing a traditional §1031 Exchange transaction is filled with challenges and hurdles. In our current landscape, amidst the pandemic and city/governmental/municipal/business shutdowns, now more than ever the process of identifying replacement properties, conducting proper and sufficient due diligence (i.e. getting appraisals, inspections, title & insurance, etc.), and actually finalizing the closing process and recording the sale with the appropriate county offices can be a long and arduous process. DSTs can offer a solution to these challenges along with the plethora of benefits outlined above. If you have more questions about the process of §1031 Exchange Transactions, how DST investments work, or how we at CPA Fiduciary Alliance can help you and your clients successfully invest in these vehicles, we have many great resources, including a virtual webinar on DST’s and QOZF’s you can watch here. Due to the complex nature of these strategies and the tax implications investors will face depending on their circumstances, you will likely need the help of a team of experts and relationships to facilitate completing a §1031 Exchange Transaction and investing in a DST investment successfully. Our goal at CPA Fiduciary Alliance™ is to assist CPAs, IARs and Real Estate Agents in this process. Please reach out to info@cpafateam.com or to myself directly below for more information on our CPA Fiduciary Alliance™ Partnership opportunities and how we can assist if you have clients interested in a §1031 Exchange or DST investment. 

Warm Regards, 

Maxwell E. Carlson, CPA

Team Lead – CPA Fiduciary Alliance™

Business Development Advisor – Caitlin John PWM

Investment Advisor Representative – Briggs Financial Group

mcarlson@epadvisornetwork.com

Maxwell E. Carlson, CPA

Team Lead – CPA Fiduciary Alliance™

Business Development Advisor – Caitlin John PWM

Investment Advisor Representative – Briggs Financial Group

mcarlson@epadvisornetwork.com

DISCLAIMER: Some of the risks related to investing in commercial real estate include, but are not limited to: market risks such as local property supply and demand conditions; tenants’ inability to pay rent; tenant turnover; inflation and other increases in operating costs; adverse changes in laws and regulations; relative liquidity of real estate investments; changing market demographics; acts of God such as earthquakes, floods or other uninsured losses; interest rate fluctuations; and availability of financing.

This is a brief and general description of certain §1031 guidelines. There are various risks related to purchasing securities as part of a §1031 exchange, including tax complexity, liquidity and restrictions on ownership and transfer. Because each prospective investor’s tax implications are different, all prospective investors should consult with their tax advisors.

Entry Point Advisor Network and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.