Exchange Real Estate Headaches for Silent and Passive Income

Recently we counseled several landowners and real estate investors as to why a 1031 Tax Deferred Exchange in tandem with a DST could be the perfect solution to solve for tax savings and passive, tax-advantaged, regular monthly income.  

A DST (Delaware Statutory Trust) is the investment structure of many institutional-quality commercial real estate developments available as a passive investment alternative for 1031 Exchange replacement property. 

Think high-end apartment developments, medical buildings, storage facility portfolios, distribution facilities for Amazon, industrial buildings, etc. These properties could potentially be great alternatives for those who are less enthusiastic about investing in the stock market upon selling their real estate.

DSTs can also save significant taxes when used alongside a traditional 1031 Exchange. The institutional-quality investments can range from fifty to over two hundred million dollars in capitalization, placing them out of reach for most investors who would not have the ability to put a deal together of this size on their own and without the DST as an option. Most DST offerings can accept investments as low as one hundred thousand dollars.

The Problem

Many people who have created wealth in real estate are now in or near retirement and may no longer want to deal with the headaches associated with owning investment real estate.

Late-night phone calls, difficult renters, vacancies, repairs, loan obligations, and accounting are among the many headaches associated with owning income-producing property.

One family we recently counseled had just purchased a one hundred thousand dollar Airstream travel trailer and was setting out for a grand nine months on the road. The family-owned rental homes that they knew had grown in value from their property tax statements. They checked, and their rental homes had indeed appreciated nicely, but they continued to have challenges with renters and vacancies.

The family had purchased three rental homes many years ago and had learned that the three homes today were worth over $1,000,000. But, unfortunately, their accountant had fully depreciated the homes during the years that they owned them, making their basis next to nothing.

That meant that they would sell her homes for $1,000,000; they would be writing a check to the IRS for $200,000.

The husband and wife were sick to their stomachs; considering how much in taxes they would pay that they considered just keeping the properties and dealing with the headaches. However, the family figured that if they did sell and pay the tax, their financial advisor would want them to buy stocks and bonds, and they knew she was not comfortable with that in today’s environment.

The Solution

A Tax-Deferred 1031 Exchange has been a regular part of our tax code for almost 100 years.

Every CPA knows the powerful advantages of tax deferral. The trouble was that before 2005 someone would have to go out and find a replacement property that they were then forced to own, manage, and operate themselves.

The 1031 exchange solved the tax deferral, but for many investors, it did nothing to help them get away from all of the headaches that come with owning an investment property.

In 2005, when the IRS approved commercial, institutional quality investment real estate as “replacement property,” property structured with the DST configuration changed the game forever.

Investors could now use the 1031 exchange and invest in passive high institutional quality income-producing properties where all active management was effectively outsourced.

DST investors have no personal loan guarantees or personal liability of any kind. 

The investor plays no part in managing, running, or operating the investment.

They collect monthly tax-advantaged checks for income which begins, in most cases, within 30 days of the 1031 Exchange.

Problem solved!

Landowners

Landowners selling their land can also take advantage of the same opportunities. However, the land often produces little to no income, and a family might be dealing with higher and higher taxes. At any time, someone could go out and get hurt on the property, and the family could end up in a significant lawsuit.

The sale and 1031 into a DST structure could potentially solve all of these issues, and more importantly, provide reliable, attractive monthly income distributions that come with an attractive tax-favored treatment. In addition, in the DST structure, the investor gets a pro-rata share of benefit from the depreciation and amortization of the property.

The real estate firms that offer DSTs are typically huge and well-established.

JLL, for example, has over 90,000 employees in over 80 countries. They are one of the largest owners of institutional quality real estate globally.

Cantor Fitzgerald, another primary sponsor of DSTs, has 13,000 employees in 150 offices worldwide.

Inland Private Capital out of Chicago has 1,500 employees and, as of this time, is the largest sponsor of DSTs in the US.

It is essential to know who is behind the real estate and their history and track record. Therefore, Provident 1031 works only with the largest and most tenured “best of breed” sponsor firms.

DSTs have similar risks to other real estate endeavors, so the investor must read the Private Placement Memorandum and consult with an advisor. In addition, registered securities offerings are only available through properly licensed and credentialed RIA Broker-Dealers.

Furthermore, the investor must meet the “accredited investor” qualifications which state that the investor must have investable assets over $1,000,000 excluding one’s residence and/or $200,000 of income as a single person or $300,000 as a married couple.

There is more to know about the accredited investor status and much more to learn about DSTs as a possible solution for tax and financial planning.