As an investment and financial advisor, you significantly influence the decisions your clients make about investing. They trust you to know the market's ins and outs and craft your recommendations with their best interests in mind. You can undoubtedly guide your clients toward achieving their goals for retirement, philanthropy, and giving as well as maintaining their financial health.
To do all that requires a financial advisor to stay knowledgeable about a wide range of investment options beyond equities and fixed income. For example, real estate can be an attractive part of an investment portfolio, but property isn’t as simple to manage as some other investment options.
How can I help my clients pursue investments in real estate?
While many investors have direct real estate investments, not all are familiar with some of the tools that they can use to help manage taxes and streamline investing. While your real estate-savvy clients have probably heard of 1031 exchanges, they may not know enough to feel confident in pursuing the transaction. It’s even less likely that they have a working knowledge of DSTs (Delaware Statutory Trusts). In both cases, you can provide value by exposing the client to these potential investment tools.
Seeking legal capital gains tax deferral
When your clients have a successful real estate investment, the good news is mitigated by the realization that selling a property at a profit triggers an obligation to pay capital gains tax on the appreciation. Your client would most likely prefer to reinvest the entire proceeds into their next asset. You can help them in that endeavor by suggesting the use of a 1031 exchange and investment in a DST.
How does a 1031 exchange work?
One of the keys to success with a 1031 exchange is planning ahead. While the IRS has proven flexible in defining “like-kind” property (virtually any commercial property will qualify), the timelines for an eligible exchange are not lenient. The clock starts ticking when the initial property (called the relinquished asset) is sold, and they must complete the whole deal within 180 days. Within those 180 days is another deadline—the taxpayer must identify potential replacement property within 45 days of the original sale.
One key aspect of a successful 1031 exchange is that both the purchase price and debt load for the new property be equal to or greater than the sales price and debt of the property sold. So, for example, if your client sells an asset for $200,000, they must reinvest the entire $200,000. Also, the investor can't have access to the funds during the transaction period; they must be under the control of a Qualified Intermediary, a neutral professional who manages the exchange process.
Can my client execute a 1031 exchange into a DST?
Completing a 1031 exchange into a Delaware Statutory Trust is allowed by the IRS. Investors can also use a 1031 exchange to exit at the appropriate time. One of the advantages of a DST investment that your clients may not be aware of is the ease with which they can customize their investment amount. In many cases, the investor can participate in a DST at precisely the level they need to either completely reinvest the proceeds from a relinquished property or fill in a gap if they have one.
What are the advantages of a DST?
In addition to the accessibility of using a 1031 exchange, the DST has other attractive features. Investors are protected from the liability that the trust has. Investors own fractional shares of the trust, which in turn owns the real estate assets the sponsor identifies and acquires. Beneficiaries (investors) have no control over the trust’s operations. The sponsor manages the property, usually through a master tenant, and distributes income periodically to the investors based on their ownership percentage. Revenue can fund necessary maintenance and repairs but can’t be used to make improvements or buy additional assets. Also, sponsors can’t renegotiate loans, add debt, or revise lease agreements unless a tenant declares bankruptcy.
For some investors, DSTs offer attractive opportunities for passive commercial property ownership. In addition, since DSTs are pass-through entities, the income may have tax advantages. However, DST participation is limited to accredited investors and is best for those with a long-term investment horizon.
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.
The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.
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.
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.
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.
