If you’re investing in a DST via a 1031 exchange, you’ll benefit by having knowledge of Revenue Ruling 2004-86. The cornerstone ruling allowed 1031 exchanges into DSTs (Delaware Statutory Trusts) while solving the problem of using TICs (tenant-in-common) as a 1031 exchange vehicle. In fact, TICs have faded in favor of DSTs when doing a 1031 exchange. Read on to learn more important details about this ruling.
Revenue Ruling 2004-86, which went into effect on July 20, 2004, allowed property owners to 1031 exchange real property for undivided fractional interest in real property. The result is an investment in a DST and deferral of capital gains. All 1031 exchange rules must be followed for the deferment of gains to be a success. The ruling meant that DSTs holding real property were fixed investment trusts.
Before Ruling 2004-86, investors utilized TICs via Rev. Proc. 2002-22. This ruling let investors 1031 exchange real property into an undivided interest in real property.
Ruling 2004-86 also classified DSTs as an investment trust rather than a business entity for federal income tax purposes. The following are some restrictions for this classification to hold.
Do investors executing a 1031 exchange into a DST need to memorize the above? No, but they should be familiar with this ruling and its caveats. Awareness of the ruling’s restrictions is another bit of risk mitigation knowledge that investors can add to their toolbox.