When investing in Delaware Statutory Trusts (DSTs), it’s not unusual to then reinvest the proceeds into another, ensuring continued tax-deferral benefits and passive income. However, as each new investment begins, the complexity of tracking the DST basis becomes more and more intricate.
Basis tracking is an essential aspect of any DST investment, particularly ones that qualify under 1031 exchanges, and losing sight can lead to major unwanted surprises in the future. That said, Realized 1031 is here to share the importance of this practice and the best habits you can follow to position yourself for success.
The Importance of DST Basis Tracking
The basis is an important figure in accounting and taxation, as it’s what the IRS uses to determine your taxable gain or loss when you sell or exchange a real estate asset. You arrive at the figure by calculating the amount you originally paid to enter the DST, plus improvements and closing costs. Then, you reduce the depreciation you’ve taken over time.
When 1031 exchanges are involved, the basis simply transfers from one DST to another, since there is no sale recognized. There are no rests or restarts, unlike traditional sales. Thanks to this process, you keep your original basis from the very first exchange, no matter how many exchanges have happened.
The challenge emerges from every new transaction: depreciation schedules, selling expenses, and exchange costs. With these additional variables, DST basis tracking becomes more complex. Even so, it remains important not to lose track of the basis, as this could result in overstating or understating gains. You could pay too much tax or trigger an IRS audit. Losing track of the basis could also result in losing depreciation records, which can distort your tax position.
With proper tracking, you ensure that you pay what you owe once a taxable event occurs and avoid penalties or an IRS investigation, resulting in a more accurate tax position and greater financial security.
Best Practices for DST Basis Tracking
Proper tracking demands consistency. To avoid being overwhelmed, especially when you own fractional interests across multiple DSTs, here are some best practices you can follow:
1. Create a Master Basis Ledger
The master basis ledger is a single spreadsheet or database where you list each DST investment chronologically. Maintaining accurate and up-to-date records in this ledger is crucial to providing you with an overview of each investment. Include details like the following.
- Original purchase date and exchange ID
- Carryover basis from the prior property
- Capital improvements or sponsor expenses
- Annual depreciation deductions
2. Store Closing and Exchange Documents Securely
Having digital and hard copies of closing statements, qualified intermediary reports, and final sale statements for each disposition provides you with sources for verifying numbers during a new exchange or audit.
3. Work With Experienced DST Professionals
From your CPA to your tax advisor, make sure that you’re engaging with experts who are knowledgeable about 1031 exchanges and DSTs. These professionals are the ones who handle the bulk of DST basis tracking.
4. Reconcile Every Year
Each year, update your basis to reflect depreciation claimed and any reinvestments. Waiting until the DST liquidates can lead to missing information and expensive reconstruction work later.
5. Make Use of Modern Innovations
Various types of tracking software are now available to help streamline the process. These dedicated digital tools can help automate both basis tracking and depreciation. Plus, the programs help reduce human error and make the processes more efficient.
In Summary: DST Basis Tracking for Investors
Tracking your DST basis may be a complicated undertaking, but it’s an essential process to ensure that you’re paying what you owe once a taxable event occurs. Practicing comprehensive tracking habits and working with experienced professionals can help you with this task, ensuring a clear and defendable history that’s ready for a liquidation event.
Sources:
https://www.delawareinc.com/blog/what-is-a-delaware-statutory-trust/
https://www.investopedia.com/articles/investing/060313/what-determines-your-cost-basis.asp
https://www.delawareinc.com/blog/what-is-a-delaware-statutory-trust/
