The 1031 exchange is often discussed in the real estate investment sector. This tax-deferral mechanism allows investors to defer capital gains taxes on an investment property when it is sold, as long as another “like-kind” property is purchased with the profit gained by the sale. When the relinquished property closes, the person conducting the exchange has 45 days to identify their potential replacement properties. In total, one has 180 days to acquire the replacement property. Your exchange is completed in 180 days.
Worth noting: A less-used execution called a reverse exchange exists. The Reverse Exchange is the opposite of the Delayed Exchange. Reverse Exchange allows the Exchanger to acquire property first and relinquish property second with a few other requirements involved. A qualified intermediary can address the “rules” for you.
This can be a powerful tool for those looking to reinvest in the real estate market without immediately incurring tax liabilities.
However, managing physical real estate can be burdensome. From ongoing maintenance to managing tenants, the day-to-day responsibilities can detract from the benefits. Imagine swapping your bustling beachfront property in Florida for something more … well, less alligator-adjacent. This is where a Delaware Statutory Trust (DST) offers a compelling alternative.
A DST is a legal entity created as a trust under Delaware law that can be used to hold title to investment real estate. Essentially, when investors contribute to a DST, they are buying a share of the trust, which in turn owns property or properties. This structure diversifies an investor’s portfolio while reducing the direct burdens of property management.
Benefits of investing in a DST
1. Elimination of Management Responsibilities: Investors in a DST are not involved in the management of the property. This responsibility is handed over to professional real estate managers, which can be particularly appealing for retirees or those not interested in the hands-on aspects of property management.
2. Access to Higher Quality Properties: DSTs often hold institutional-grade properties, which might be out of reach for an individual investor. These can include large commercial buildings, multifamily apartments, and other high-value properties that offer potentially better returns and stability.
3. Diversification: By investing in a DST, you can own a fraction of multiple properties across different geographical locations and sectors, spreading risk more effectively than individual property ownership.
4. Eligibility for 1031 Exchanges: DSTs qualify as “like-kind” property for 1031 exchanges. This means investors can move from actively managing properties to being a passive investor without incurring capital gains taxes at the time of the exchange.
5. Streamlined Financing: Since the DST holds the title to the real estate, financing structures are often more straightforward. This can be advantageous compared to the often complex financing scenarios encountered with individual property ownership.
While the benefits are significant, DSTs are not without their downsides.
1. Investors in a DST give up control over the property, relying on the trust’s managers to make all operational decisions.
2. There can be minimum investment requirements and liquidity constraints to consider.
3. The amount of capital needed in one project may not match the amount of money you had planned to defer and invest.
4. Project types may not match the exact type of property you previously owned.
For those considering an exit from direct real estate investment, or looking to use a 1031 exchange without continuing to manage properties, a DST offers a viable alternative with several strategic benefits. It’s almost like setting your property management responsibilities adrift on a raft down the Florida Keys – relaxing and without the alligator chases.
My wife Brittany and I have owned and operated real estate since college. It started as a hobby and now simply holds anchor for portfolio diversification purposes. The real estate market is more precarious now with less appealing economics compared to easier ways to earn a return. Deferring the tax along with outsourcing could certainly be a benefit!
As always, it’s crucial to consult with a financial and tax adviser to understand fully how such an investment fits into your broader financial landscape.
Evan R. Guido is the founder of Aksala Wealth Advisors LLC, a 2018 Forbes Next-Gen Advisors List Member, and Financial Professional at Avantax Investment ServicesSM. Evan heads a team of retirement transition strategists for clients who consider themselves the “Millionaire Next Door.” He can be reached at 941-500-5122 or eguido@aksalawealth.com. Read more of his insights at heraldtribune.com/business. Securities offered through Avantax Investment ServicesSM, member FINRA, SIPC. Investment advisory services offered through Avantax Advisory ServicesSM, insurance services offered through an Avantax-affiliated insurance agency. 6260 Lake Osprey Drive, Lakewood Ranch, FL 34240.
