During our December networking event we had the pleasure of welcoming Justin Freeman, CPA as our guest speaker. He was generous enough to share his wealth of tax knowledge with us. One of the strategies he highlighted was performing a 1031 exchange but with a slight twist. Instead of reinvesting your proceeds from a property sale into another local investment property to defer your capital gains you can invest in Delaware Statutory Trusts (DSTs).
I have put together some of the benefits and the process for doing a 1031 into a DST here but if you are looking for more specific advice, you can reach out to Justin or another CPA. I am not an accountant and this blog should be considered tax advice.
What Is a Delaware Statutory Trust (DST)?
A DST is a legal entity that allows multiple investors to own fractional shares in a single property or portfolio of properties. These are typically large-scale commercial assets such as office buildings, multifamily apartments, retail centers, or industrial parks. This is a much more passive form of ownership than your typical investment property.
Benefits of Doing a 1031 Exchange into a DST
- Diversification
DSTs often include institutional-grade properties in multiple geographic locations, offering diversification that can reduce risk. - Passive Management
DST investments are managed by a professional sponsor. This eliminates the burden of hands-on property management, making it ideal for investors seeking a more passive role. - Access to High-Value Assets
Through fractional ownership, DSTs allow you to invest in large-scale properties that would typically be out of reach for individual investors. - Predictable Income
Most DSTs provide regular distributions from rental income, creating a reliable cash flow. - Ease of Estate Planning
Fractional ownership interests in DSTs are easier to divide among heirs, simplifying estate planning.
How Does a 1031 Exchange into a DST Work?
Here’s a general overview of the process:
1. Identify and Sell Your Property
Begin by listing and selling your current investment property. Vista Real Estate Brokers would be happy to help with this!
2. Work with a Qualified Intermediary (QI)
A 1031 exchange requires the use of a Qualified Intermediary to hold the proceeds from your sale. You cannot take possession of these funds directly, or your exchange will be disqualified. Maine Exchange Services is a fantastic QI that I have used in the past.
3. Identify Replacement Properties
You have 45 days from the sale of your property to identify potential replacement properties, which can include one or more DST investments. Work with your QI and your CPA to help make sure you’re in compliance.
4. Conduct Due Diligence on DST Investments
Research available DST offerings. Key factors to consider include the type of property, location, projected income, sponsor reputation, and associated risks.
5. Reinvest Proceeds into the DST
Once you’ve chosen a DST, the QI will transfer your funds to complete the purchase. The entire transaction must be finalized within 180 days of your initial property sale.
Considerations Before Investing in a DST
While DSTs offer numerous benefits, they’re not without risks. For example:
- DST investments are illiquid, meaning you cannot easily sell your share.
- There is no direct control over the management of the property.
- Like all real estate investments, DSTs are subject to market fluctuations.
It’s crucial to consult with financial advisors, tax professionals, and real estate experts to determine if a DST aligns with your investment goals.
Conclusion: Is a 1031 Exchange into a DST Right for You?
A 1031 exchange into a DST can be a great strategy for investors looking to defer taxes, diversify their portfolios, and enjoy a hands-off investment experience. Whether you’re transitioning from active management to passive income or seeking access to institutional-grade properties, DSTs offer flexibility and financial benefits that align with long-term investment goals.