Jessica Schmidt (not her real name) is a qualified intermediary for a large national firm specializing in 1031 exchanges for investment real estate. Lately, she has been working 10-hour days, six days a week.
Some days she takes up to 50 calls a day from real estate investors seeking to cash in on a hot real estate market without paying large sums of tax on their highly appreciated real estate investment.
It's a seller’s market, and most real estate investors can garner a quick sale on amounts they had previously only dreamed of.
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.
Everything's great, right? Not so fast.
A Seller's Market Isn’t Exactly a Dream
Jessica usually spends 10-15 minutes with a caller explaining the rules and regulations of a 1031 exchange. She often refers callers to her website for educational videos on the 45-Day Rule, the 3 Property Rule, and the 180 Day Rule. These are all essential and specific requirements for an investor to take advantage of our tax code’s ability to defer taxes upon a property sale.
She explains that the seller must open an exchange "ticket" BEFORE the sale of their investment property closes. Then the seller has up to 45 days to identify a qualified replacement property.
And that’s where the situation gets sticky.
Problems Finding Replacement Properties
"The problem with the inventory in the marketplace is that there isn't any," the chief economist for a large national title company was quoted as saying at a recent economic forum.
Today, more often than not, hopeful 1031 exchange investors find themselves in quite the conundrum. According to Jessica, the high-ticket sale and the tax deferral via the 1031 exchange may be the easy part, but finding a suitable replacement property seems to be the biggest obstacle and a common dilemma.
A Potential Solution – DST, or Delaware Statutory Trust
With that in mind, Jessica has been increasingly offering her clients a different option to consider instead of a 1031 exchange: a DST, or Delaware Statutory Trust.
DSTs are passive real estate investments that qualify as replacement property for 1031 exchanges. DSTs invest in multifamily apartments, medical buildings, self-storage facilities, Amazon distribution centers, industrial warehouses, hotels and other vital real estate asset classes. The investments are passive in nature and generate regular monthly income to investors and the potential and opportunity for growth.
Many DSTs are syndicated with some debt, usually about 50% loan-to-value. However, the debt to investors is considered non-recourse, which means that an investor has no personal guarantee or personal liability for such debt. This could be very helpful, Jessica explains to her clients, because they all want to receive a full tax deferral, and the rules stipulate that in an exchange, the investor must reinvest the sale proceeds AND replace any debt.
DSTs have been around since 2004 when the IRS issued Ruling 2004-86, which made DSTs qualify for replacement in a 1031 exchange.
Must Be an Accredited Investor
DSTs are for “accredited” investors only, which means that an investor must have a net worth of at least $1 million apart from their primary residence or have an income of $200,000 for a single person or $300,000 for a married couple. And DSTs are offered as SEC-registered securities and therefore are obtained from broker-dealers or registered investment advisers. The advisers perform extensive due diligence on the real estate syndications and each specific DST-sponsored property.
Jessica concludes that DSTs could be a perfect solution for many of her clients and investors, especially those getting closer to retirement and maybe not wanting to actively manage real estate assets any longer. Between the tax savings, the passive nature of the investments, and the high-quality assets that are generally part of DSTs, many of her clients’ problems could be effectively solved using this important passive investment strategy.
Although DSTs are attracting billions of dollars of investment funds, most CPAs and real estate investors are still unaware of this important and viable solution that could potentially solve so many problems for so many real estate investors.
After explaining all this so many times in calls from clients the past several months, Jessica decided to come up with the following “Letterman” style Top 5 Benefits of DSTs for her clients:
5 Top Benefits of DSTs in a 1031 Exchange
1. Potential Better Overall Returns and Cash Flows
It depends upon the investor. Still, some investors find DSTs could offer a better risk-return profile than a property they might manage themselves.
2. Tax Planning and Preserved Step-Up in Basis
DSTs offer the same tax advantages of real estate that an investor would own and manage themselves. Depreciation and amortization are passed along to DST investors by their proportionate share. DSTs can be exchanged again in the future into another DST via a 1031 exchange.
3. Freedom
Passive investing allows older real estate owners the time and freedom to travel, pursue other endeavors, spend more time with family, and/or move to a location removed from their current real estate assets.
4. As a Backup Strategy
In a competitive market, an investor may not be able to find a suitable replacement property for their 1031 exchange. DSTs might be a good backup option and could be named/identified in an exchange if only for that reason.
5. Capture Equity in a Hot Market
When markets are at all-time highs, investors may want to take their gains off the table and reinvest using the leverage inside a DST offering.
DST investments come with a risk common to real estate investing and are offered to accredited investors only and by private placement memorandum only. Therefore, a prudent investor would be best served by evaluating all details of each specific offering and the track record of the sponsor firm before investing in a DST offering.
-
7 of Warren Buffett's Biggest MissesWarren Buffett's investing wins are highly regarded across Wall Street, but no one can bat a thousand. Here are some of Buffett's biggest misses.
-
Why Toll Brothers Stock Is Falling After EarningsToll Brothers stock is lower Wednesday after the homebuilder missed expectations for its first quarter. Here's what you need to know.
-
Rethinking Income When You Retire: No Paycheck, No ProblemWhen you retire, you'll need to adjust to the reality of depending on assets instead of a regular paycheck. For that, you'll need a new financial strategy.
-
How to Support Your Parents Without Derailing Your FinancesPutting your aging parents' financial house in order can give you a clearer picture of where they need support and how to balance that with your own plans.
-
Why 'Standard' Digital Background Checks Can Be So UnreliableMissing online data, as well as stringent federal and state privacy rules, make it difficult to discover a prospective employee's or tenant's criminal past.
-
Are You a High-Income Earner? Three Unexpected Reasons to Save More Than You Think You ShouldHigh-income earners sometimes put off saving because they think they have plenty of time and money to do it later. That's not always the case, though.
-
How Financial Professionals Can Empower Their Female ClientsThese three strategies can help advisers better serve women as they navigate unique financial challenges and build confidence.
-
Student Visas: Older Americans' Ticket to Living in EuropeDo you envision strolling about Europe, a book in one hand, a glass of wine in the other? You could make that happen by studying there, even if you're older.
-
Three Reasons It May Be Time for an Annuity 'Refresh'Because of higher interest rates, inflation and newer annuity products, you could get a better deal today. Don't wait, though: Interest rates could start falling.
-
Three Common Cash Flow Mistakes and How to Fix ThemBetter cash flow management could have a bigger impact on your retirement savings than simply making more money. Here's how to manage that.
