In her iconic song “D-I-V-O-R-C-E,” Tammy Wynette sings about the heartbreak of a couple that is separating. Throughout the song, Wynette spells out the difficult words, to ensure that the couple’s four-year-old son remains blissfully ignorant about the parents’ breakup.
These days, those who find themselves in the situation outlined by Wynette’s song understand the emotional toil that can come through marital separation. There are also the hard questions, such as division of wealth. In this case, three more letters – D-S-T, or Delaware Statutory Trust – can help determine what to do with the assets, especially if they consist of income-producing real estate.
DST vs. Real Property
We’ve written extensively about the Delaware Statutory Trust, a vehicle in which you, the investor, buy an interest, or fractional share in income-producing real estate. Your investment gives you a “beneficial interest” in that property which, in turn, is owned and managed by a DST trustee, or sponsor. Over the course of ownership, you potentially receive income from your shares and, when the property is sold, the proceeds come to you and other investors in the trust.
We’ve also discussed, in previous articles, how you can relinquish physical real estate into a “like-kind” DST through a 1031 Exchange, thereby deferring capital gains taxes. Unlike real estate, your DST is a fixed unit trust, a security, as opposed to physical property. The yields on such investments can be approximately 5%-7%. Additionally, such trusts can provide a more tax-efficient method of dividing real estate assets, especially in situations in which distrust might be more the exception, than the rule. Such as divorce.
Dividing the Proceeds
Taking a hypothetical example, let’s say you and your spouse are in the midst of a divorce, and your asset pool consists of investment properties you co-own. Understanding that you don’t want to be co-property owners anymore, you decide to sell the assets. You do so and split the proceeds, only to find out at tax time that you are now on the hook for a whopping capital gains tax.
If you had exchanged out of those properties and straight into a DST, you and your soon-to-be ex might still receive income flow from investments, without worry about capital gains tax. And, once the trust is dissolved, you could take the proceeds from those shares and put them into another tax-deferred investment vehicle, exchange them into another DST or funnel it back into real property, without needing your ex-spouse’s permission or approval.
Here’s another potential scenario. Let’s say that, in the divorce settlement, you owe your spouse a certain amount of money. But, as most of your funds might be tied up in real property, you decide to deed some of that real estate, in lieu of cash, to your soon-to-be ex.
Your spouse might hang onto that property, because he/she likes the income and relishes being a property owner. However, the chances are pretty good this isn’t the case; so, your spouse sells the asset for the ready cash. Imagine his/her surprise at tax time, when the capital gain tax needs to be paid. Best-case scenario, you could find yourself on the receiving end of a very nasty e-mail or phone message for more money. In the worst-case scenario, could find yourself in court, in front of a judge, being sued for not meeting your settlement responsibilities.
A much better option to avoid both taxes and the fallout might be for your ex to take that property, ensure it is in his/her name, use the 1031 Exchange process to relinquish it, then funnel the proceeds into a like-kind DST. Your former wife or husband retains interest in real property, and receives income from it, without having to pay taxes.
Making the Difficult Somewhat Easier
Tammy Wynette’s sad song says it all: Divorce is not easy. Separating from a spouse can be emotionally and physically draining, especially when it comes to deciding how the assets should be split. However, if you are able to respectfully negotiate the distribution of any income-producing property you own, a DST could be ideal to help keep your wealth intact, while deferring any taxes from proceeds.