Four Ways Savvy Investors Use DSTs for Their 1031 Exchanges

Regardless of what economic trends are taking place, Delaware Statutory Trusts (DSTs) continue to provide investors certain timeless benefits for their 1031 exchanges and direct cash investments, including deferring capital gains taxes, eliminating the headaches of active management (think the Three T’s: tenants, toilets and trash) and the ability to create a more diversified portfolio. On top of that, DSTs have the potential to provide investors consistent and durable income streams with the ability to achieve modest appreciation potential.(1)

However, there are at least four concrete ways real estate investors can use DSTs as a strategic tool for their 1031 exchanges in today's challenging real estate market:

1. Debt Replacement.

One of the most popular uses of DSTs for a 1031 exchange involves not having to secure financing. For example, if you are in the midst of a 1031 exchange in today’s unstable debt market, you are likely having a difficult time finding a mortgage to satisfy the 1031 exchange rules. DSTs, however, are designed to make it easy to invest in without having to deal with qualifying for and taking on a mortgage on own’s own.

Subscribe to Kiplinger’s Personal Finance

Be a smarter, better informed investor.

Save up to 74%

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.

Sign up

That’s why many investors find DSTs also make a suitable primary investment option for 1031 exchanges. For example, Kay Properties has a variety of leveraged DSTs that are pre-structured with non-recourse debt already built in, typically ranging from 30% to 70% loan to value (LTV). Because DSTs typically do not require you to have to qualify for a loan or even fill out loan documents, DSTs can create a reliable tool for you to access high-quality real estate investments without having to jump through the hoops of getting approved for a loan.

2. Cover Strategy.

Another popular use of DST investments comes in the form of providing a cover strategy for leftover equity. Let’s say you sell one property and cannot find a suitable replacement property that uses the full exchange proceeds, and you now have leftover equity you need to place. One of the benefits DSTs can provide you in this situation is the ability to enter one without investing a lot of money. Because DSTs require a low minimum investment amount (typically $100,000), they can be a good way for you to use any extra 1031 exchange proceeds to avoid having a "boot" and having to pay capital gains taxes on it. Placing the leftover exchange proceeds into a DST property can potentially allow you to achieve full tax deferral for your 1031 exchange.

Here’s an example of how DSTs can provide a cover strategy for your 1031 exchange. Let’s say you need to replace a $3 million purchase price for a 1031 exchange, but your real estate broker finds a property for $2.7 million. By investing the leftover $300,000 in a DST, you could avoid the taxable boot. In this way, you could successfully complete your 1031 exchange by acquiring both a real property investment and a DST investment with an aggregate value of $3 million.

3. Diversification and True Passivity.

You have probably heard the expression “don’t put all your eggs in one basket.” If you decide to invest in one single-tenant net-leased property or one multifamily apartment building for your 1031 exchange, that’s exactly what you could be doing. However, DST properties can potentially allow you to achieve a level of diversification that you would not be able to achieve if you bought only a single NNN asset or multifamily building on their own. An NNN property is one that has a triple net lease attached to the asset. This requires the tenant to be responsible for payment of a portion of the property’s operating expenses. These expenses typically include building maintenance, insurance, property taxes and utilities.

By investing in a DST, you have access to a diversified portfolio of properties that are often high-quality real estate offerings with very large tenants that are professionally managed and potentially provide monthly cash distributions. In addition, you can also achieve a truly passive management structure, eliminating the headaches of the Three T’s.

Investing in a single-tenant property, on the other hand, means you are relying heavily on the quality of a sole tenant. If that tenant fails to pay rent or even files bankruptcy, your income could likely be reduced or even completely eliminated. Similarly, would you invest all of your 401(k) into one company’s stock, even if that company is Amazon or Apple? Your answer is probably no. No matter how great a company is, you probably do not trust it with all of your family's wealth. In the same way, there is no perfect investment property. You may be able to mitigate your potential exposure to the various risks of real estate by diversifying. DSTs allow for diversification among a number of different income-producing properties.

4. Back-Up Option.

Another (albeit less familiar) strategy investors should be aware of if they are considering a DST is to use it as a back-up option for their 1031 exchange. Why is this an important factor to consider? Let’s say that you have successfully sold your investment property and are now proceeding to search for replacement properties that you can manage on your own. In today’s market, you may discover that identifying and closing on high-quality “like-kind” assets within the specified time frame is not as easy as it sounds. This is when DSTs can be used as a backup option.

The reason for this is because DSTs are pre-packaged specifically for 1031 exchanges, so they can potentially be a very helpful tool to have in the bag in case your primary real estate property option falls through and you're facing a failed exchange. In addition, because of the turnkey nature of DSTs, you can often close on them within just three to five days to give you a strategy to successfully complete your 1031 exchange.

DST properties continue to be one of the most popular passive investment options for 1031 exchanges. Knowing how to best use DSTs to avoid common 1031 exchange challenges, you will be better situated to potentially complete your exchange and avoid the expensive taxes that could accompany a failed exchange.

(1) Past performance does not guarantee or indicate the likelihood of future results. No representation is made that any DST investment will or is likely to achieve profits or losses similar to those achieved in the past or that losses will not be incurred on future offerings.

Diversification does not guarantee returns and does not protect against loss.

Kay Properties is a national Delaware Statutory Trust (DST) investment firm. The www.kpi1031.com platform provides access to the marketplace of DSTs from over 25 different sponsor companies, custom DSTs only available to Kay clients, independent advice on DST sponsor companies, full due diligence and vetting on each DST (typically 20-40 DSTs) and a DST secondary market. Kay Properties team members collectively have over 150 years of real estate experience, are licensed in all 50 states, and have participated in over $30 Billion of DST 1031 investments.

This material does not constitute an offer to sell nor a solicitation of an offer to buy any security. Such offers can be made only by the confidential Private Placement Memorandum (the “Memorandum”). Please read the entire Memorandum paying special attention to the risk section prior investing. IRC Section 1031, IRC Section 1033 and IRC Section 721 are complex tax codes therefore you should consult your tax or legal professional for details regarding your situation. There are material risks associated with investing in real estate securities including illiquidity, vacancies, general market conditions and competition, lack of operating history, interest rate risks, general risks of owning/operating commercial and multifamily properties, financing risks, potential adverse tax consequences, general economic risks, development risks and long hold periods. There is a risk of loss of the entire investment principal. Past performance is not a guarantee of future results. Potential cash flow, potential returns and potential appreciation are not guaranteed.

Nothing contained on this website constitutes tax, legal, insurance or investment advice, nor does it constitute a solicitation or an offer to buy or sell any security or other financial instrument. Securities offered through FNEX Capital, member FINRA, SIPC.