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Nov.November 12, 2020 02:30 PM

Enjoy the Diversity of Fractional Real Estate Investments with the Tax Advantages of Direct Ownership

Combine the potential benefits of a diversified real estate portfolio with the tax advantages of direct property ownership by investing in a professionally managed Delaware Statutory Trust.

Diversification is a crucial component of a well-crafted investment portfolio. Savvy investors have long sought portfolio diversification through commercial real estate. Real estate can provide investors with many potential benefits, such as tax-deferred income and appreciation from assets that aren’t correlated to strong stock market performance. Diversification from uncorrelated assets also potentially reduces overall investment risk.

You can enjoy these potential advantages by investing in a Delaware Statutory Trust (DST). DST investors purchase fractional interests in institutional-grade assets that typically are out of reach for many solo investors. DST offerings are pre-packaged — they’ve already been acquired by a DST sponsor, eliminating the need for you to conduct lengthy and costly due diligence. DST assets also are professionally managed, so you won’t have to deal with the ongoing duties and concerns associated with direct property ownership.

Perhaps most importantly, though, DSTs offer investors shelter from capital gains tax liabilities, a benefit not available through some real estate investment products. With accessible minimum investment amounts and tax-deferred eligibility through 1031 exchanges, DSTs can provide some of the most attractive benefits of direct property ownership and can help manage potential drawbacks typically associated with publicly traded investment vehicles.

 

What are Delaware Statutory Trusts?

Delaware Statutory Trusts (DSTs) provide individual investors access to institutional-grade investment properties that can be much larger in scope than assets they would be able to acquire by themselves. These are the same professionally managed properties commonly owned by REITs, pension funds, endowments, sovereign funds, and insurance companies. Assets can span a range of property types, such as:

  • Self-storage facilities
  • Industrial warehouses and distribution facilities
  • Multi-family apartments
  • Office and retail centers
  • Medical office buildings

DSTs offer 1031 exchange-eligibility for investors upfront and also on exit, a benefit usually unavailable with other fractional ownership structures. DSTs can potentially provide recurring tax-advantaged monthly income that can be offset from tax liability through depreciation deductions.

Since DST are pre-packaged and have accessible minimum investment amounts, accredited investors can use this investment vehicle to craft diversified investment portfolios that help manage and potentially reduce their risk profiles.

 

What are 1031 Exchanges?

A 1031 exchange is an investment strategy that allows investors to sell their investment properties and defer any potential capital gains taxes by reinvesting proceeds into like-kind replacement assets.

In addition to capital gains taxes, investors can also defer tax liabilities such as depreciation recapture and the Affordable Care Act surtaxes. Since the IRS allows subsequent 1031 exchanges whenever you sell an investment property, you can potentially continue growing your wealth tax-free. Investors can use the 1031 exchange process to swap properties until their death, whereupon they can bequeath their interests to their heirs, who can receive a one-time step-up in basis that can effectively eliminate all capital gains liabilities.

There are two key deadlines you need to know about 1031 exchanges. First, you have just 45 days to identify up to three replacement assets. Second, you have 180 days to close, so you definitely need to do some advance planning before divesting your investment property.

 

Benefits of 1031 DST Exchanges

There can be many benefits of investing in a Delaware Statutory Trust. In addition to being eligible for 1031 exchanges, DSTs can potentially speed up the exchange process through pre-packaged offerings of institutional-grade assets. These assets often are of higher quality and greater in size than investors could afford on their own. Additionally, DSTs eliminate a potential stumbling block for 1031 investors by allowing you to invest the exact amount needed to satisfy the “like-kind” exchange requirement. You also can invest in multiple Delaware Statutory Trusts to create portfolio diversification through varying asset classes and geographical locations. Lastly, DST investments that incur debt typically have mortgage financing in place. These loans are non-recourse, though, which protects your assets outside of the DST loan.

 

Potential Drawbacks of DSTs

There are some potential risks and disadvantages with Delaware Statutory Trust 1031 exchange properties. Investors can’t raise new capital from additional investors once the initial offering closes, so large capital expenditures such as resurfacing parking lots or replacing roofs can erode investor returns. Investors also surrender personal control of their investments — DST properties are professionally managed. You won’t have any input in how the property is managed or run. Illiquidity is another concern. Hold times for DSTs usually are between five and ten years. While there is a secondary market for selling DST interests, there’s no guarantee you’ll be able to divest your interests for an equitable price.

 

How to Defer Capital Gains Taxes by Completing a DST 1031

There are three steps required to complete the 1031 exchange process and ensure eligibility for deferring capital gains liability after selling an investment asset.

1: Prepare Beforehand. Seek advice from your tax advisor and accountant to make sure a Delaware Statutory Trust 1031 exchange is in line with your investment goals. They also can help you better understand your minimum investment and loan-to-value requirements.

You will have to engage a Qualified Intermediary (QI) to hold the proceeds from your relinquished investment property in escrow until you find a suitable replacement. The Qualified Intermediary also will coordinate all administrative requirements to complete the 1031 exchange.

2: Find a Replacement Asset. DST properties are usually sold by registered broker-dealers. However, they typically only offer a handful of DST investment opportunities. Due to regulatory changes, Realized now offers an online marketplace where 1031 exchangers can browse a much wider range of real property investments.

3: Complete the Process. Once you select a suitable replacement property, you’ll need to verify you meet the requirements of an accredited investor. If approved, you’ll make a deposit that secures your position in the DST investment. After that, you’ll notify your QI about your replacement asset. The QI prepares and completes all the paperwork needed to release your 1031 funds to the escrow agent in charge of closing on the replacement asset. All of this legwork must be completed 180 days after you sell your relinquished asset.

 

Should You Invest In a Delaware Statutory Trust 1031 Exchange?

Due to their longer hold times, DSTs may be best suited for patient investors willing to sit on the sidelines and have their assets managed by others. Conversely, some DST investors want out of the landlord game and are enticed by the prospect of fractional interest in professionally managed institutional-grade commercial properties.

Some investors complete DST 1031 exchanges to diversify their real property holdings, while others just want to shelter income from capital gains taxes after selling their investment properties.

DSTs, while more illiquid than some types of real estate investment vehicles, allows investors to craft diversified commercial real estate portfolios while maintaining direct property tax benefits — mainly capital gains deferral and depreciation. Regardless of whatever scenario you find most appealing, be sure to consult with your tax professional and financial advisor to determine which course of action best suits your investment philosophy.

This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions.

The actual amount and timing of distributions paid by programs is not guaranteed and may vary. There is no guarantee that investors will receive distributions or a return of their capital. These programs can give no assurance that it will be able to pay or maintain distributions, or that distributions will increase over time.

Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.


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