PASSIVE INCOME POTENTIAL
A properly structured 1031 DST legal trust allows an investor to sell an investment real estate asset, defer the taxation on the sale through Internal Revenue Code Section 1031 and buy a DST replacement property on a tax-deferred basis.
The DST investor will own a portion of the trust, called a Beneficial Ownership Interest, with the trust owning the underlying real estate. There will be multiple DST owners and each will own his/her own percentage of the trust. A DST investor is called a DST Beneficiary and will receive the potential economic benefits of the property held in the DST. For 1031 tax-deferred exchange and income tax purposes, the investor is viewed by the IRS to own the real estate directly. For all other purposes, the investor is seen as a passive participant.
Examples of DST real estate include multifamily apartment buildings, self-storage, senior care facilities, grocery-anchored shopping centers, single-tenant net lease buildings (NNN), office buildings, industrial properties and warehouses. In many cases, DSTs can offer opportunities for enhanced cash flow potential from rental income and tax benefits from the depreciation of assets.
Prior to Exchange: Sold an industrial property and was in escrow on their up leg, and the lender wanted recourse on the loan. Client’s 45-day ID period ran out and he needed a quick solution to defer over $1M in capital gains taxes.
After (Tax-Deferred) Exchange: Closed on three DST properties consisting of multifamily and Industrial assets that seek long-term income potential.
Prior to Exchange: Sold a single-family home in Laguna Beach that was eventually rented on Airbnb. The city changed the laws on short-term rentals and disrupted her income.
After (Tax-Deferred) Exchange: Owns an interest in four DST properties that consist of multifamily, retail, and Healthcare seeking a repeatable potential income stream.
Michelle & Stan
Prior to Exchange: Sold a large retail shopping center with other owners. One owner died, which forced the sale.
After (Tax-Deferred) Exchange: They own an interest in six DST properties and are free from management headaches while enjoying the tax-advantaged income potential.
Jim & Susan
Prior to Exchange: Inherited a property and owned it for 50 years. Expenses were killing their income, which they relied upon for retirement. Capital gains tax would have accounted for about 50% of their equity.
After (Tax-Deferred) Exchange: Own an interest in five DST real estate properties of multifamily and retail assets.
Prior to Exchange: Owned a gas station and sold the land and the business after many years of ownership and retirement in San Diego.
After (Tax-Deferred) Exchange: Exchanged into three multifamily assets.
Joe & Alice
Prior to Exchange: Sold a mixed-use property because reduced vacancy was affecting their retirement income. Tried finding a Triple Net with a strong credit tenant, long-term NNN lease and their 45-day ID period ran out.
After (Tax-Deferred) Exchange: Identified DST properties on the 45th ID date and closed on 6 DSTs three days after avoiding the tax liability.
Prior to Exchange: Lives out of state from a property he owned for 30 years with long-term tenants.
After (Tax-Deferred) Exchange: Owns interest in multiple DSTs that consist of multifamily, self-storage, retail, healthcare and a REIT (721 UPREIT).
Rick & Raella
Prior to Exchange: Sold an out-of-state commercial building that was used by their business that was no longer needed.
After (Tax-Deferred) Exchange: Brother and sister retired and wanted to exchange into a REIT, so they could liquidate in phases and divide those assets for estate planning purposes.
POTENTIAL ADVANTAGES OF A DST
No Property Management
DSTs are ideal for owners who don’t want to deal with facility management, tenants, maintenance and property taxes.
Monthly cash flow potential may exceed original property
Capitalization rates historically have been between 5 to 7% cash-on-cash return on equity investments.* The DST seeks to deliver stable income potential generated from credit-worthy tenants who can enjoy the income from the property while letting a professional team manage it
*Rates are not a guarantee and may change at any time. Past performance does not guarantee future results.
The potential for greater capital investment appreciation on your present equity
A DST is good for investors who want to trade up to higher quality investment grade properties that are returns of a professionally managed, institutional type commercial property with credit-worthy tenants. It provides individual investors the ability to compete with institutional investors on larger deals by pooling funds for larger properties than they normally wouldn’t be able to afford. They can leverage the sponsor’s acquisition departments.
Benefits include continuation of tax deferral – until step-up in basis and new depreciation allowance – as much as 50% to 80% of potential cash flow sheltered from taxes, typically. We believe it has the potential to be an excellent estate planning vehicle – estate tax valuation discounts of up to 35% for a DST interest (i.e. further discounts may be available with proper planning).
Short holding period on property ownership
A majority of sponsors only hold the properties on average about 6.5 years, so investors are then able to take their net proceeds to “exchange” into a property of their own choosing or another program to further defer their taxes. DSTs are illiquid investments, so investors should plan on being invested for the life of the investment. If you are seeking liquidity, there are other strategies we can utilize that seek to achieve these goals.
Real estate diversification
Investors can spread their equity amongst multiple sponsors, such as, DST offerings, geographic location, leases, tenants, asset classes, etc., (over a dozen to choose from) and property types (office, apartments, industrial, duplexes, shopping centers, retail, warehouse, malls, etc.)
It is a great “backup” replacement vehicle
It can act as a backup if a primary replacement property does not close (i.e. may not have time to identify another property). If the appraisal for the primary replacement property comes back for less than the “gain” needed to be sheltered, DSTs can accommodate “spillover/last piece fill” from a large transaction. If you do not want to spend the time necessary to secure (as well as to do the due diligence) on good quality replacement property and if you are having trouble finding good replacement property in a tight market, DSTs may be a option if suitable.
RISKS OF A DST COULD INCLUDE
- Market and property risks: The value of the property held by the DST can fluctuate based on changes in interest rates, supply and demand, economic conditions, environmental conditions, zoning, etc. which means the appreciation generated could vary.
- Lack of liquidity: DSTs are generally illiquid so they may not be easily sold or exchanged.
- Fees and expenses: Investing in a DST can involve high fees and expenses
- Limited control: As an investor in a DST, you have limited control over the property held by the trust, and you may not be able to make decisions regarding the management or operation of the property.
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