A 1031 exchange is a promising strategy that helps investors defer capital gains taxes while acquiring new property, but this transaction involves many rules. One important yet often overlooked aspect of the transaction is debt replacement, as it doesn’t always apply. However, for properties that do have debt, failing to replace it when acquiring a new asset can result in tax liability. Thankfully, solutions are available, including financing built for Delaware Statutory Trusts (DSTs).
In this article, we will look at how you can use DST financing to meet IRS rules when acquiring suitable 1031 debt replacement properties.
The idea of debt replacement stems from the rules outlined by the IRS to ensure compliant 1031 exchanges. While there are many regulations, the following three requirements are significant:
Securing financing is a challenge in itself. There are many requirements that investors must secure, like credit checks and personal guarantees. Qualification becomes even more challenging because of the strict 1031 exchange timeframe, which lasts only for 180 days. If you’re an investor who has retired or has high leverage, then qualification may be more rigorous, while other investors simply don’t want to take on a new personal debt.
Thankfully, DSTs have debt structures that allow you to resolve these challenges.
DSTs are legal entities that acquire and operate income-generating properties, which can include institutional-grade assets. Purchasing these properties often requires financing, and for DSTs, this debt is non-recourse. Investors can then step into fractional ownership where financing is already secured.
This structure means that you, as an investor, won’t need to qualify for any financing. Plus, you’re free to choose DSTs that already match your specific debt replacement requirements. For example, if you have a $300,000 debt from the relinquished property, you can simply find a DST offering that has similar or proportionate leverage. Not only does this structure remove rigorous requirements, but it also speeds up the process. You’re less likely to exceed the 180-day timeline and maintain your tax-deferred status.
While DSTs streamline debt replacement, this shouldn’t be the only reason you enter one. There are other factors to keep in mind to bring you closer to a successful investment.
The non-recourse debt of DSTs, plus their prepackaged nature, makes them ideal for 1031 exchange investors who need streamlined debt replacement solutions. As DSTs provide ease and speed, you can quickly acquire a replacement asset that helps you avoid boot or going over the 180-day timeframe. In other words, you avoid the stress of securing a traditional loan and increase the chances of a successful investment.
Sources:
https://apps.irs.gov/app/vita/content/36/36_02_020.jsp
https://nstp.org/memberarea/federaltaxalert/2023/what-is-boot-in-a-1031-exchange
https://www.investopedia.com/financial-edge/0110/10-things-to-know-about-1031-exchanges.aspx