If investors choose to invest through a 1031 exchange for the tax-deferral benefits, they'll need to understand the many rules that govern the transaction. One of these rules is the 45-day identification period, which is further complicated by the minimum number of properties they are required to identify. Thankfully, Delaware Statutory Trusts (DSTs) have features that help investors easily satisfy these requirements.
In this article on the DST 200% rule and three-property minimums, Realized 1031 shares the mechanisms that make DSTs a strategic option.
Understanding the Identification Rules
In 1031 exchanges, the IRS sets a 180-day timeline to finish an entire transaction. The first 45 days are the identification period. Investors must identify potential replacement properties and formally submit details about each asset to their qualified intermediary.
How many properties do investors need to identify? The standard point of reference is the three-property rule. Identify up to three assets, regardless of their aggregate market value. This rule is the simplest, as it allows investors to have two backups in case their top choice isn’t available.
However, some investors have surplus capital or are aiming for diversification. Three properties aren’t enough for them, so they choose to follow the 200% rule. In this case, an investor can identify as many replacement properties as they want, provided that their cumulative fair market value does not exceed 200% of the sales proceeds from the relinquished property.
How DSTs Allow for Easier Identification
DSTs, which allow investors to invest by purchasing interests, have features that create conditions for easier property identification.
Three-Property Rule
The main struggle of the three-property rule is identifying assets that have a similar or greater value than the relinquished property, all while having features that the investor wants. DSTs streamline identification by being pre-packaged investments. Additionally, investors can purchase as many DST interests as needed to meet the equal-or-greater-value requirement.
DST 200% Rule
Similarly, the structure of DST interests allows investors to identify multiple DSTs while staying within the 200% rule requirement. Most DSTs allow them to invest as much capital as they want, with minimum entry requirements as low as $100,000. This way, investors can easily identify several DSTs to satisfy diversification needs while remaining compliant.
By purchasing multiple DSTs under the 200% rule, investors also enjoy other benefits.
- Enhance diversification by investing in DSTs across multiple asset classes or industries.
- Reduce the chances of boot, since investors can control how many DST interests they acquire for each DST offering.
- Commit a precise amount of capital and close quickly, minimizing the risk of missing the 45-day identification or 180-day closing deadlines.
Tips for Investors
To further increase the chances of success during the identification period, here are some best practices to follow.
- Determine an identification strategy by counting underlying properties. If a DST owns multiple assets, each property within the DST counts toward an investor’s identification limits. Choose the three-property rule if identifying three or fewer total properties (across all DSTs), or use the 200% rule if identifying more properties while staying within the 200% value limit.
- Satisfy the debt replacement requirement by finding DST offerings with similar or greater debt than the relinquished asset.
- Remember that DSTs can serve as backup replacement properties. Having DSTs ready helps investors comply with the 45-day rule in case the primary property they identified falls out of contract.
Wrapping Up: How DSTs Help With Identification Compliance
The pre-packaged nature of DSTs and the low entry requirements make them ideal for investors who want to streamline the 45-day identification period. Whether following the three-property or 200% rule, DSTs make it easier for investors to match value requirements and enhance diversification. These features make DSTs a dependable option for minimizing compliance risks and increasing the likelihood of a successful exchange.
Sources:
https://www.americanbar.org/groups/real_property_trust_estate/resources/real-estate/1031-exchange/
