Maybe you’re ready to do some estate planning and are figuring out what to do with that rental cottage in the Berkshire mountains, or the small office property you own in Texas. You might be thinking of leaving that property to your family or donating it to your alma mater or favorite charity.
In theory, a real property gift or donation might be a good idea. Your heirs or charity of choice could continue benefiting from the income stream, then receive proceeds from the property’s sale. In reality, however, gifting or donating real estate may be problematic.
Investments in a Delaware Statutory Trust (DST) might be one way to structure a gift or donation of real estate, without incurring the potential side effects for you, your heirs or charitable organizations.
Real Property Could Mean Real Headaches
First, let’s look at the potential consequences of your donation.
Your Beneficiaries. While that Berkshire rental home offers a decent cash flow, your family and/or heirs and/or partners might not care. In fact, once you are gone, the future of that house could be a topic of heated discussion.
Your spouse and oldest son might want to sell, and distribute proceeds to the grandkids. Maybe the middle child will argue that the family should hang onto the property, while the youngest wants to sell, and roll the proceeds into another property. Few things cause more discord among family members than what to do with real property in an estate.
If you’re leaving that house to your investment partners, something similar could occur. Your partners might not agree on what to do with that house. While they’re arguing, there is money that needs to be spent on taxes, insurance, and maintenance.
Your Charities. Perhaps you want to gift that Texas office building to a senior canine sanctuary. The problem? While the staff knows everything about caring for older dogs, the chances are pretty good it has little real estate expertise.
Remember, your favorite charity is probably not in the real estate business. This means the organization would have to hire outside management to look after the asset, which could cut into revenues. If someone is injured on the property, or environmental issues discovered, the sanctuary could end up being held responsible. If repairs are needed, once again, the sanctuary is responsible for it. And, what if the organization decides to sell the building? Now they have to find a broker, go through due diligence, negotiate a contract, and complete closing of the transaction - not necessarily easy tasks. And what if the property doesn’t sell as expected? It could end up being an administrative burden and possibly a liability to the charity.
Your Tax Deduction. Finally, while that donation may provide you with some tax deductions benefits, the IRS imposes annual charitable giving limits, which makes it unlikely that the donor receives tax benefits for the full value of the gift. The nondeductible portion of the donation could leave you open to a large capital gains tax. You could also lose the tax advantages of real-estate generated income, as well as the ability to adjust donations over time.
The DST: A Possible Solution
By selling your property and then rolling the proceeds (via 1031 exchange) into a Delaware Statutory Trust (DST), you buy an interest (similar to buying shares in a stock) in institutional-grade real estate, which is professionally managed by the investment’s Sponsor. By doing this, you have essentially transformed your tangible, illiquid, “hands-on”, real property into a passive, “unitized” security that gives you more flexibility for gifting and estate planning.
Benefit for the Beneficiaries. You, your family, and/or heirs and/or partners can receive income from the DST (at the direction of the initial beneficiary), without being responsible for the management and operations of the actual real estate. The initial beneficiary may also transfer their units to family members and heirs (subject to accredited investor status and other security transfer provisions). And, subject to annual gifting limits, the initial beneficiary may actually be able to transfer the interests over time without recognizing capital gains taxes and allowing for (perhaps) more efficient estate planning.
Once the “units” have been transferred, and underlying property is sold, the different partners and family members can do their own thing with the proceeds. They may choose to pay taxes and cash out, exchange the proceeds into another DST, exchange their proceeds into direct property, or some combination thereof. Due to the “same taxpayer provision,” this is generally not possible with other legal ownership entities such as an LLC or partnership.
Benefit for the Charities. Because of the passive investment structure of the DST, the charity no longer has responsibility for repairs and maintenance, management or dealing with tenants. The charity is also not in a position where they may have to prepare the property for sale, and/or manage the sales process of the the asset. Instead, the charitable organization receives income from the DST and, once the underlying property in the DST sells, the charity may be able to cash out (depending on tax status) or rollover the proceeds.
Benefit for the Donor. While the donor still owns the DST, they have control of where the income should be directed and can change direction and/or amounts at any time. With proper estate planning, the “units” can be transferred over time in order to maximize the tax benefits to the donor. One thing to keep in mind, however, is that the IRS has a lot of rules when it comes to donations and gifting. Make sure you speak with a professional before embarking on any kind of estate planning and/or gifting.Interested in using your investment real estate for charitable giving? Concerns about passing on your property to your heirs in a tax-efficient manner? As with any investment decision, there are many factors to consider. At Realized 1031, we’re happy to talk with you to determine if such a solution meets your personal objectives.
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