Investors seeking to defer capital gains taxes on the sale of commercial real estate often purchase shares of Delaware Statutory Trusts (DSTs) to complete 1031 exchanges.
DSTs essentially allow investors to swap their solo interests in investment properties for fractional shares of a trust that’s backed by various types of commercial properties or by a portfolio of real property assets. Although the trust holds 100 percent ownership of its assets, the trustees, or beneficiaries, potentially receive recurring distributions as well as favorable tax treatment since the IRS views ownership of shares in a DST as real property ownership.
Investing in a Delaware Statutory Trust and completing a 1031 exchange can be tricky, though. There can be quite a few pitfalls that can trip up both novice and experienced investors alike. In this article we’ll take a closer look at how an experienced attorney can help with the Delaware Statutory Trust investing process.
Experienced Attorneys Can Be Beneficial for DST and 1031 Exchange Investors
Investing in real estate can be rewarding, but it also can be complicated -- especially for investors trying to complete 1031 exchanges. There are numerous ways legal counsel with prior experience in Delaware statutory trusts can assist you with important investment decisions.
The IRS has firm rules on 1031 exchanges. Investors must adhere to these strict federal guidelines to properly complete their exchanges and defer capital gains taxes on the sale of relinquished properties. One single mistake could result in a disqualification -- and a hefty tax burden.
Legal counsel with prior 1031 exchange experience can help DST investors avoid issues with the following processes:
- Identifying like-kind replacement properties within 45 days of the sale of your relinquished asset.
- Closing on the like-kind replacement within the 180-day window.
- Holding replacement assets for at least one year.
- Receiving funds from the sale of relinquished assets.
- Designating a Qualified Intermediary to hold your sale proceeds during the exchange process. In some states an attorney may be able to act as your QI for the exchange, but it can’t be your regular counsel -- he or she can’t have worked with you in the past two years.
Attorneys with experience in real estate law could potentially offer expert insight and guidance to help exchangers avoid mistakes that could disqualify their exchanges. They also can provide counsel throughout the exchange process to ensure investors adhere to these and other important IRS guidelines.
The Bottom Line
There are certain pros and cons associated with investments in Delaware Statutory Trusts. Additionally, the Internal Revenue Service rules about 1031 exchanges and Delaware Statutory Trusts are rigid and inflexible. One mistake could disqualify your exchange.
Investors with prior DST investing experience may be able to navigate the complexities of Delaware Statutory Trust investments and 1031 exchanges on their own. However, novice investors or first-time exchangers should strongly consider engaging the services of an attorney with knowledge of real estate law, Delaware Statutory Trusts, and 1031 exchanges to ensure they fully understand the laws and regulations relating to each type of transaction.
There are material risks associated with investing in DST properties and real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal. Past performance is not a guarantee of future results. Potential cash flow, returns and appreciation are not guaranteed. IRC Section 1031 is a complex tax concept; consult your legal or tax professional regarding the specifics of your particular situation. This is not a solicitation or an offer to sell any securities. DST 1031 properties are only available to accredited investors (typically have a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last three years) and accredited entities only. If you are unsure if you are an accredited investor and/or an accredited entity please verify with your CPA and Attorney.