Real estate can be a terrific investment. As an alternative investment asset, it can help diversify a portfolio. And, depending on the asset class, type, location, and other factors, it can appreciate in value, while offering a steady rate of return.
There is one large problem with direct real estate investing, however. You can’t physically divide it to transfer ownership to someone else. In this scenario, the only way to transfer ownership is through a sale, gift, or probate, all of which can involve a somewhat lengthy, and at times, legal process.
There are, however, two easier ways to transfer ownership of real estate property, one of which is to roll your ownership into a Delaware Statutory Trust (DST) through a 1031 exchange. Once the exchange is completed, you can use your DST shares as part of a gifting or estate-planning process.
A review: Defining the DST
We’ve provided a great deal of information about Delaware Statutory Trusts in the past. So, to review:
- A DST is a legally-recognized trust in which property is held, managed, and invested.
- A DST provides opportunities for fractional ownership. In other words, as a DST investor, you own shares of a trust, rather than owning a property outright.
- As a DST owner, you are a passive investor. The trust takes on asset and property management responsibilities, allowing you to potentially receive income without the hassles of being a landlord.
- Neither you -- or the property in question -- needs to be in Delaware.
Another plus with this form of investment is that the DST qualifies as real estate in the eyes of the IRS. This allows you to use the 1031 exchange process to dispose of your current real estate property, and acquire DST shares, with the added plus of deferring taxes on capital gains.
DST for estate planning
The other added plus with this procedure is that transferring ownership of a real estate DST can be much easier than with physical real estate.
This is because in rolling over the proceeds from your physical real estate into a DST, you have, in a sense, transformed the investment into a “unitized” security. In addition to potentially providing more diversity for your investment strategy and portfolio, the process can allow more flexibility when it comes to estate planning and your heirs.
For one thing, if you decide to transfer ownership of your shares to someone else, either as a gift or part of your estate, the beneficiary won’t have to deal with hands-on real estate management, and will enjoy the income. Furthermore, the initial beneficiary may also transfer their inherited or gifted units to other family members or heirs, subject to accredited investor status and other security transfer provisions. In addition, depending on annual gifting limits, that beneficiary could also be able to transfer the DST interests over time, without having to recognize capital gains taxes.
Another potential benefit is that your heirs might not have to pay capital gains taxes on those DST shares when you pass away. This is possible through a step-up in basis, which can help greatly reduce, or eliminate, what is owed to the IRS.
Splitting an asset, the DST way
As with any investment, there is a degree of risk. As such, a discussion with a tax attorney or financial advisor should be a first step when it comes to determining any kind of transfer ownership of real estate property. But, utilizing a 1031 exchange to transfer real estate holdings into a DST can help make future ownership transfers much less onerous.