Recently I met an investor named Mark, who had sold an apartment complex where they had done an awesome job completing a value-add strategy to the building. All the hard work had paid off, and they had a strong buyer. Only problem? The dramatic haircut from taxes owed that they would receive if they sold and pocketed the cash.
Inventory in Multifamily apartment properties is 1/3 of what it was on average from 2018-2022. This means for those that have a need or desire to do a 1031 exchange, the options are becoming increasingly limited.
With historically low inventory in the apartment market, Mark was looking at Short Term Vacation rentals as the best replacement option to do a 1031 exchange, since the housing market is showing more velocity than the apartment market. However, the Short-Term Market has reached a point of saturation in many markets that has turned the financials less favorable.
The Solution | Introducing the Delaware Statutory Trust (DST)
A Delaware Statutory Trust (DST) is a legal entity that allows multiple investors to hold fractional interests in a single property or portfolio of properties. DSTs have gained popularity as a 1031 exchange vehicle due to their flexibility and potential benefits.
Many investors like Mark may not be familiar with this option because it straddles the fence between a Real Estate offering and a Security. Indeed, many real estate brokers you talk to may not be familiar with this option, and likewise, some Securities Investment professionals may not be familiar with DST’s being an option for a 1031 Exchange. Because neither professional is well versed, many clients may never encounter this suggestion from both their advisors in both securities and real estate.
The reason for this is because the Securities and Exchange Commission have put careful parameters on the sale of participation into syndication funds, of which a Delaware Statutory Trust is a type of syndication fund. However, it is unique from many syndications in how the title to the property is taken, which then will permit an investor to engage in a 1031 Exchange, as it is satisfies the requirements of holding title of the replacement property in the same name as the property being sold.
Key Advantages of a DST in a 1031 Exchange
1. Passive Investment
Delaware Statutory Trusts offer a passive investment structure, allowing investors to own fractional interests without the responsibilities of property management. This is particularly attractive to investors seeking a more hands-off approach. This is often a primary reason for sellers in 1031 exchanges, as many look to sell properties with more management duties and exchange into more passive investments like NNN Lease properties.
2. Diversification
DSTs often include larger, institutional-grade properties such as apartment complexes, commercial buildings, or storage facilities. By participating in a Delaware Statutory Trust, investors can access a diversified portfolio that might otherwise be out of reach.
3. Ease of Use
DSTs simplify the 1031 exchange process. Investors can identify and close on their replacement property within the tight deadlines required by the IRS, reducing the risk of a failed exchange.
4. Potential Income Stream
Delaware Statutory Trusts typically distribute rental income to investors on a regular basis, providing a reliable income stream that can supplement other investments or serve as passive retirement income.
5. Asset Protection
Holding properties within a DST can provide a degree of asset protection, shielding individual investors from the liability associated with property ownership.
Potential Risks and Considerations
While Delaware Statutory Trusts offer significant advantages, it’s essential to be aware of potential risks and considerations:
1. Lack of Control
Investors in DSTs have limited control over property management decisions. They rely on a trustee to make those choices, so it’s crucial to thoroughly vet the trustee and trust structure.
2. Illiquidity
Delaware Statutory Trusts typically have a fixed investment term, making them illiquid investments. Investors should be prepared for their capital to be tied up for the duration of the trust.
3. Limited Exit Options
Exiting a DST can be challenging. There’s no secondary market for Delaware Statutory Trust interests, so investors may need to sell their interest privately or wait until the trust’s term expires.
A Delaware Statutory Trust (DST) can be a powerful tool for real estate investors looking to maximize the benefits of a 1031 exchange. By providing passive ownership, diversification, and simplified 1031 exchange processes, DSTs offer an attractive option for investors seeking to defer capital gains taxes and optimize their real estate portfolios.
With this solution in hand, Mark was able to fulfill his need for a 1031 Exchange with a placement that was sourced from his financial advisor and can enjoy a more passive strategy as he looks toward retirement.
Need a recommendation or have questions on this strategy? We are always happy to discuss and look forward to being your trusted advisor.
