Many people like to round out their portfolios with real estate investments.
Some start small. They purchase a starter house, rent it out and keep going from there. Others, including high-net-worth investors, like the idea of diversifying their holdings, and real estate is often a good alternative — especially when bond yields are weak and the stock market is volatile.
Both types of investors are looking for steady returns that can hold up against inflation.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
As they age, however, many of those who truly enjoyed managing properties in their 30s and 40s find they just don’t want to do it anymore. They tire of answering late-night calls about clogged drains, worrying about finding new tenants or dealing with insurance policies and other paperwork.
They don’t want to tussle with the taxes, either, and the thousands of dollars they’ll owe Uncle Sam if they sell their properties.
Most are aware they can use a 1031 exchange (or, colloquially, a Starker exchange) to defer paying capital gains taxes on a sale by reinvesting the proceeds in a replacement property — but that doesn’t really solve their problem if they want to get away from being a landlord. So, when our clients come up against this situation, we discuss the pros and cons of using a 1031 exchange to put their money into something called a Delaware statutory trust (DST).
A DST ownership offers most of the same benefits and risks you have as an individual property owner, but without the management responsibility. Instead, you put your money into a fund along with other investors — sometimes 100, possibly more — to buy a property that will be professionally managed.
The asset might be a retail space, a health care center, a fitness center or an apartment building. Most are larger properties that some investors couldn’t get into unless they were pooling their money with others. But, as in the similar Tenants in Common (TIC) structure, there’s no majority vote on issues; one trustee makes all decisions. That means many of the nagging worries of ownership go away, which can make retirement decidedly more pleasant.
For example, our firm just started working with a widow who has more than $2 million in investment real estate all over the Washington, D.C.-Northern Virginia area: townhouses, condos, some single-family homes. But this was her husband’s thing, and he passed away several years ago. She is now in her 60s and managing these properties, and she knows that as she gets older, she’s not going to want to continue doing it.
After looking at the rate of return on her different properties — and calculating what she actually keeps after taxes, insurance and other expenses — we found that she’ll have a better return with a DST. It’s a win-win, so she’s decided to start selling off these properties.
When she dies, if the money is still in a trust, her children will inherit it on a stepped-up cost basis, just as they would with regular real estate, and they will collect the yield until the DST liquidates. At that point, they can do another exchange, take the money out or handle it any way they like.
There are downsides, of course. Investors should know that their cash will be tied up for the length of the fund, which is usually about seven to 10 years but could be longer.
And there are specific rules for how you set up the investment. If your intent is to use the trust with a 1031 exchange, you must be sure it meets the requirements of Revenue Ruling 2004-86. That includes using a qualified intermediary — an attorney — because the money from the sale cannot go into your personal bank account. It must go to the attorney and then into the trust.
You also should talk to your tax professional if you’re considering this strategy.
And you’ll want to work with a knowledgeable, experienced financial professional. An independent fiduciary can help you make sure the DST sponsor is solid and above-board — and that a DST fits with your overall retirement plan and your long-range goals.
Kim Franke-Folstad contributed to this article.
This article and the opinions in it are for general information only and are not intended to provide specific advice or recommendations for any individual. We suggest that you consult your accountant, tax or legal adviser with regard to your individual situation.
Examples are for illustrative purposes only and may not be indicative of your situation. Your results will vary.
Securities offered only by duly registered individuals through Madison Avenue Securities, LLC (MAS), Member FINRA & SIPC. Advisory services offered only by duly registered individuals through Brighter Financial Capital Management, LLC, a SEC Investment Advisor. Insurance products and services are offered through Clark & Associates, Inc. Financial Solutions, an affiliated company. Brighter Financial Capital Management, LLC and MAS are separate entities, independently owned.
The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.
Related Content
-
When Should You Hand Over the Keys — to Your Investments?The secret to retirement planning? "The best time to hand over the keys is before you’ve realized you need to hand over the keys."
-
A checklist for high-net-worth individuals looking to maintain and grow their wealth.A strategic guide to managing, preserving, and expanding your wealth for long-term financial security.
-
Going to College? How to Navigate the Financial PlanningCollege decisions this year seem even more complex than usual, including determining whether a school is a 'financial fit.' Here's how to find your way.
-
Financial Steps After a Loved One's Alzheimer's DiagnosisIt's important to move fast on legal safeguards, estate planning and more while your loved one still has the capacity to make decisions.
-
How Soon Can You Walk Away After Selling Your Business?You may earn more money from the sale of your business if you stay to help with the transition to new management. The question is, do you need to?
-
Two Don'ts and Four Dos During Trump's Trade WarThe financial rules have changed now that tariffs have disrupted the markets and created economic uncertainty. What can you do? (And what shouldn't you do?)
-
I'm Single, With No Kids: Why Do I Need an Estate Plan?Unless you have a plan in place, guess who might be making all the decisions about your prized possessions, or even your health care: a court.
-
Most Investors Aren't as Diversified as They Think: Are You?You could be facing a surprisingly dangerous amount of concentration risk without realizing it. Fixing that problem starts with knowing exactly what you own.
-
Will My Children Inherit Too Much?If you worry about how your children will handle an inheritance, you're not alone. Luckily, you have options — from lifetime gifting to trusts — that can help.
-
Charitable Giving Lessons From Netflix's 'Apple Cider Vinegar'Charity fraud is rife, and a Netflix series provides a timely warning about donating money to a good cause without looking into its background.
