Estate planning is complex, particularly if many of your assets are in real estate. Determining an equitable division can be challenging if you are distributing real estate to a group of heirs. To devise a fair distribution, you must evaluate market value, asset performance, liquidity, geography, and more. If you bequeath one property to be shared by multiple heirs, you may unintentionally create conflict between the recipients.
Another consideration when preparing to decide the division of assets is whether the intended recipients of your property have experience with or interest in managing real estate. If you leave real estate to an heir with no time for or interest in managing that property, the heir may fail.
How can DSTs simplify my estate planning?
Moving from active real estate ownership and management to passive investment in DSTs (Delaware Statutory Trusts) can simplify your portfolio now and ease potential conflicts for your heirs. Suppose you are nearing retirement and would prefer to reduce your active involvement in property management.
However, you own several assets that have enjoyed significant capital appreciation. If you leave these properties to your heirs, they will benefit from the “step-up” in value, so they will not owe capital gains taxes. But if you sell the properties now to instead leave a share of the cash value to each person, you will be responsible for capital gains taxes on the profits, which will reduce the value of your bequest.
Use a 1031 exchange to transition into DSTs.
One unique advantage of DSTs is that you can enter and exit one using a 1031 exchange. In this example, you can sell the office property through a 1031 exchange and replace it with shares in DSTs. The IRS considers DST participation to be direct ownership, which makes shares of a DST eligible for use as replacement property in a 1031 exchange.
Furthermore, exchanging into a DST solves one of the challenges of a 1031 exchange: the need to identify potential replacement property within 45 days of the sale of the relinquished asset and acquire replacement property within 180 days of the sale. Because DSTs are available to accredited investors, you can choose one in any amount you need if your investment meets the minimum requirement.
Suppose you want to divide the value of a $1,000,000 office property among your three heirs. You can sell the building and purchase three different DST interests. You can customize the amounts and have the freedom to choose the sector focus, geographic location, and class. In that case, each heir receives a free-standing asset they can keep or sell at maturity or use to 1031 exchange into another real estate investment.
Provide greater utility to your designated heirs.
Since direct real estate ownership can require significant involvement, and sharing an asset may provoke disputes in the group, exchanging into a DST before distributing the assets offers an attractive solution. The heirs can enjoy the benefits of real estate ownership without management hassles. DSTs are managed by a professional Sponsor with overall responsibility for decision-making, allowing the investors to pursue their real estate goals without needing daily involvement.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
All real estate investments have the potential to lose value during the life of the investment. All financed real estate investments have the potential for foreclosure.
All investments have an inherent level of risk. The value of your investment will fluctuate with the value of the underlying investments. You could receive back less than you initially invested and there is no guarantee that you will receive any income.
Costs associated with a 1031 transaction may impact investor’s returns and may outweigh the tax benefits. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.
No public market currently exists, and one may never exist. DST programs are speculative and suitable only for Accredited Investors who do not anticipate a need for liquidity or can afford to lose their entire investment.
There is no guarantee that the investment objectives of any program will be achieved.
Hypothetical examples shown are for illustrative purposes only.