Basics of a 1031 Exchange
Section 1031 of the Internal Revenue Code allows an investor to defer the payment of capital gains and depreciation recapture taxes that may arise from the sale of investment real estate. By using the proceeds of this sale to acquire “like-kind” real estate, taxes may be deferred, as long as the investor meets certain conditions and deadlines.
"Like-kind" Definition
The replacement property must be like-kind to the relinquished property. Generally, real estate held for business or investment purposes in the United States is considered "like-kind,” including commercial and residential property.
What does not qualify as “like-kind”?
- Primary Residence
- Indebtedness
- Stocks, Bonds or Notes
- Partnership Interests
- Inventory
Timeline of a 1031 Exchange
1. Within 45 calendar days following the closing of the relinquished property, the exchanger must identify potential replacement property(ies).
2. Within 180 calendar days following the closing of the relinquished property, the replacement property(ies) must be purchased.
1031 Exchange Process
- Exchanger sells investment property, known as the relinquished property.
- Proceeds are escrowed with a Qualified Intermediary (QI) at close of sale.
- Exchanger identifies replacement property(ies) within 45 days of sale and notifies QI.
- Identification of Replacement Property:
- 3 Property Rule – may identify up to 3 properties without regard to fair market value.
- 200% Rule – may identify more than 3 properties, if the total fair market value of all properties identified does not exceed 200% of the total fair market value of all Relinquished Properties.
- 95% Rule – any number of properties may be identified as long as the Replacement Properties acquired amount to at least 95% of the fair market value of all identified properties.
- The QI transfers the funds for purchase of replacement property(ies). Exchanger must close on replacement investment property(ies) within 180 days of the closing date of the relinquished property.
Delaware Statutory Trusts (DSTs) as Replacement Properties
A Delaware Statutory Trust (DST) is a legally recognized trust, used in a variety of transactions and structures. Its flexibility of operation and management, plus the limited liability granted to beneficial owners, have made the DST a popular vehicle for a wide array of business purposes.
In accordance with I.R.S. Revenue Ruling 2004- 86, beneficial interests in a Delaware Statutory Trust may be considered “like-kind” replacement property in a Section 1031 exchange. Title to property is held by the trust as a separate legal entity for the benefit of a beneficial owner, rather than directly, affording liability protection to the owners. Interests in the DST are considered securities under federal securities law, however, they retain treatment as ownership in real estate.
For exchange purposes, DSTs are 100% passive, turn-key investments offered by nationally recognized real estate management companies, referred to as “sponsors.” Sponsors perform the initial due diligence, structure the property acquisition, maintain and lease the property, collect rent, service the mortgage and eventually sell the property.
A DST may own one or more properties across diverse asset classes: multifamily residential real estate; net leased retail; medical office portfolios; industrial property, among others.
No Management Responsibilities
DSTs are managed by professional, third-party firms. For investors transitioning from actively managing properties to passive ownership, this alleviates the burden of day-to-day management and replaces it with the freedom of time for travel and leisure.
Tax-Sheltered Monthly Income
Distributions from cash flow are paid monthly. Because DST investors are deemed to have direct ownership of real estate, the benefits of direct ownership, such as mortgage interest deductions and depreciation, flow through to investors on a pro-rata basis. Because of this, income from DSTs is often tax-sheltered, making for a greater tax-equivalent yield.
Diversification
Because of the fractional-ownership and low minimum investment of DSTs, clients are able to replace their investment with a portfolio of commercial real estate that provides diversification of asset class, geography and even DST sponsor. This helps to mitigate investment risk.
Ease of Ownership
The rules and deadlines of a 1031 exchange, such as the “45-day identification period,” can be difficult to maneuver. DSTs are pre-vetted and already acquired, ready for an investor’s exchange. The closing process into a DST can take as little as two business days. For investors at the end of their 45-day ID period who have not yet found a suitable replacement property, DSTs can offer an immediate and simple solution. For this same reason, DSTs also make for great back-up properties, in case there are complications with a sole-property acquisition.
Higher-Value
Real Estate
A DST is a pooled-equity investment which allows investors to collectively purchase a property of higher value by aggregating their equity together. This allows DST investors to purchase properties that would otherwise be out of a single investor’s reach. As an example, a DST investor could go from owning 100% of a local apartment to owning 1.20% of a $50 million class A apartment complex in Denver, CO.
Estate Planning
DSTs, like traditional real estate upon an owner’s passing, provide heirs with a step-up in cost basis. This means that heirs do not receive the owner’s original cost basis, but a “stepped-up” basis as of the date of death. This is true even if the owner has performed multiple 1031 exchanges. DSTs can also relieve the anxiety and problems that can occur when real estate is transferred to heirs.
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When an investor exchanges property into a DST, they are obtaining a beneficial interest along with other investors in an institutional quality property that is managed by a trustee. So, the typical burdens associated with property management and loan responsibilities are effectively shifted from the investor (or heir) to the trustee. Heirs who may be otherwise averse to owning real estate due to added responsibilities may be relieved to learn that they can own income-producing real estate in a DST property structure and have very little additional work to perform other than some added tax reporting responsibilities at year end.
Fiduciary 1031 Exchange Process
Clark Wealth Strategies, Inc. provides clients with methodical, fiduciary guidance throughout the entire 1031 exchange. We’ve established a unique fiduciary process to help facilitate exchanges for clients all across the country, saving them thousands of dollars in unnecessary commissions.
Because of our independence, we are not beholden to any parent company or broker/dealer. No one is giving us a menu of investments that are to be sold to our clients. Instead, we have the freedom to use any solutions and strategies we choose, as long as it is in the best interest of our clients.
Utilizing Delaware Statutory Trusts (DSTs) and other strategies, we are able to create broadly diverse replacement real estate portfolios. DSTs allow for fractional ownership of commercial real estate and easy diversification across asset class and geography.
Any sales commissions or broker/dealer fees normally associated with DSTs are credited back to our clients in the form of additional DST equity. The end result is a very diverse replacement real estate portfolio, additional equity and a higher tax-sheltered monthly income.
Madison Farms, DST
Location(s): NC
Loan-to-Value: 0%
Offering Size: $81,173,184
Suitability: Accredited Investors Only
Industrial Portfolio, DST
Location(s): FL, KS
Loan-to-Value: 0%
Offering Size: $275,859,119
Suitability: Accredited Investors Only
Storage IV, DST
Location(s): AZ, FL
Loan-to-Value: 0%
Offering Size: $70,344,106
Suitability: Accredited Investors Only
One Riverside, DST
Location(s): TN
Loan-to-Value: 51.72%
Offering Size: $45,550,000
Suitability: Accredited Investors Only
Senior Living of Largo, DST
Location(s): FL
Loan-to-Value: 0%
Offering Size: $25,581,544
Suitability: Accredited Investors Only
Village View, DST
Location(s): NV
Loan-to-Value: 46.89%
Offering Size: $29,425,000
Suitability: Accredited Investors Only
The offerings shown above are representative of investments available in the Clark Wealth Strategies DST inventory. This is neither an offer to sell nor a solicitation of an offer to buy a DST interest. There is no guarantee that these objectives will be met.
Proud Affiliate Members of the Federation of Exchange Accommodators
