Category: 1031 Exchange

Case Study: The Zero DST

A 1031 exchange is essentially a swap of one investment property for another. The advantage of using a 1031 exchange is that it allows you to defer capital gains on appreciated investment property.

There are a number of factors to consider when doing a 1031 exchange, including potential tax implications for any debt on the exchanged property. 

Enter the 1031 exchange Zero Income DST (Delaware Statutory Trust).

A Zero DST is a form of 1031 exchange that provides a debt option to help avoid the unwanted tax implications of reduced debt that can result from a 1031 exchange.

Let’s take a look at a case study from a client who we recently helped through this process.

Morgan’s situation 

Morgan was doing a $1.7 million 1031 exchange with about $933,000 in debt. That left $767,000 in cash at the Qualified Intermediary (QI).

I received a call from Morgan and after a brief introduction and back-and-forth, he paused and asked, “Did I screw up my exchange?”  Note this is the PG-13 version of what he actually asked.

This was the beginning of the educational process. I started Morgan’s education by explaining to him that he needed to get a loan for $933,000 and is required to replace the debt that was paid off as part of the 1031 exchange. In a 1031 Exchange you have to replace the equity and the debt.  So if you closed a sale at $1.7 million that had $$933,000 in debt, you have to purchase $1.7 million of like-kind replacement real estate which includes $933,000 of debt.

You see… Morgan had outlined his “plan” which sounded great, but I asked him, “what about the debt?”  Where’s the $933,000 in debt – he interrupted, “I paid that off!”  No laughing allowed.  That’s when I had to explain to him the requirement of having to replace the debt/loan in his new purchase(s).  You can probably hear, the “OOOOOH… really?” yourself while reading this.

Morgan already purchased one property for $420,000 all cash. He was in contract for a second property for $207,000 which was to close very soon. For both properties he was planning to use all-cash to make the purchases.

What was missing in those two transactions was that there was no debt.

Using a Zero coupon DST

What a Zero coupon DST does is provide the debt needed without having to go and get a new loan.  The Zero although it provides no income, it gives you all of the debt and depreciation as if you actually had a $933,000 loan.

Morgan purchased $204,000 of a Zero Coupon DST program which was the equivalent of $934,000 of debt; which covered all of the debt from his old property. Problem solved, this eliminated virtually all of the taxes he would have faced on the elimination of the $933,000 in debt.

Morgan was like many real estate investors who are unaware of the potential tax hit from not replacing the debt eliminated from the property that is being exchanged. This can cause a 1031 exchange to literally “blow up” in an investor’s face.

If you’re considering slowing down and spending more time with your spouse/partner, the grandkids, traveling or just not dealing with the tenants, toilets, and trash, and the other headaches that can come with owning income property, let’s set up a time to talk about what that looks like.

It’s easy to schedule a meeting.  My calendar is as close as the “Calendly” link below.  Copy the link into a browser and schedule a meeting today.

?   ???? ????:  https://calendly.com/herbalston/30min

This is for informational purposes only, does not constitute as individual investment advice, and should not be relied upon as tax or legal advice. Please consult the appropriate professional regarding your individual circumstance.

The case study is for illustrative purpose only. Individual results will vary.

There are material risks associated with investing in DST properties and real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal.

DST 1031 properties are only available to accredited investors (typically have a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last three years) and accredited entities only.  If you are unsure if you are an accredited investor and/or an accredited entity please verify with your CPA and Attorney.

 

 

How to Qualify for a 1031 Exchange: A Simple Guide for Investors

Are you thinking about selling your investment property? If so, a 1031 exchange might be an excellent option! This effective tool, also known as a “like-kind exchange,” allows investment property owners to defer a variety of taxes by reinvesting their funds into another piece of property.

Qualifying for this incredible wealth-building opportunity isn’t as difficult as you might think. Here’s what you need to know. 

What is a 1031 Exchange?

Section 1031 of the Internal Revenue Code provides the ability to exchange a business, income, or investment property for “like-kind” property. Doing so allows the property holder to defer federal and state capital gains taxes and the 3.8% Medicare tax. A 1031 exchange also defers the recapture of depreciation.

The primary benefit of a 1031 exchange is the ability to hold onto your buying power. Without it, a property sale would result in you paying a significant portion of your profits to the government. This would leave you with less money to purchase a new investment. By taking advantage of a 1031 exchange, you’re able to keep all of your money working for you.

Eligibility Requirements

If you currently own business property or a piece of real estate held for income or investment, you likely qualify for a 1031 exchange. This opportunity is open to individuals, S-corporations, C-corporations, LLCs, trusts, general partners, limited partners, and any other tax-paying entity.

The primary requirements for qualifying are that (1) you have a qualifying property, and (2) you meet the time restrictions.

When you sell your property, you’ll have 45 calendar days from the closing date to identify your replacement property. You also only have 180 calendar days from the date of your first property closing to close on the replacement property. In addition, you must use a “qualified intermediary” to oversee the transaction and ensure all 1031 exchange requirements are met.

Like-Kind Property

Finding a “like-kind” property may seem intimidating. However, it’s not as complicated as you might think. As long as the new property is located in the United States and it’s used in business or held as an investment or income-producing property, it’s considered a “like-kind” property.

No matter what kind of investment, income, or business property you currently hold, you’re able to exchange it for a variety of different properties. This may include a vacant lot, apartment building, commercial building, or even a single-family residence (as long as it’s not your primary residence or second home).

In some cases, a vacation home may qualify for a 1031 exchange. However, you must show that you have “limited personal use” of the property. This means that the property owner or the owner’s family must not personally use the property for more than 15 days per year or 10% of the number of days during the year that the property is rented at the fair market value.

Personal property, like gold coins, aircraft, computers, and equipment, may also qualify for a 1031 exchange. However, the rules regarding these exchanges are much more specific. If you’re considering engaging in any kind of a 1031 exchange, it’s a good idea to consult with a tax professional before you get started.

Delaware Statutory Trust

While finding a “like-kind” property isn’t necessarily difficult, many property holders are selling their real estate holdings because they no longer want to deal with the hassles of managing physical property. The good news is, you can qualify for a 1031 exchange without the ongoing effort of managing a replacement property.

A Delaware Statutory Trust (DST) is an investment vehicle that serves as a like-kind investment property. It allows accredited investors to continue owning real estate property and enjoy the benefits of a 1031 exchange, without the headaches that come with property management.

To learn more about how to qualify for a 1031 exchange and explore whether a DST is appropriate for you, send us a message or give us a call at 415-991-1031. Remember, you only have 45 days from the sale of your property to find a replacement property, so don’t delay! 

This is for informational purposes only, does not constitute as individual investment advice, and should not be relied upon as tax or legal advice. Please consult the appropriate professional regarding your individual circumstance. Because investors’ situations and objectives vary this information is not intended to indicate suitability for any particular investor. 

 DST 1031 properties are only available to accredited investors (typically have a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last three years) and accredited entities only.  If you are unsure if you are an accredited investor and/or an accredited entity please verify with your CPA and Attorney. 

There are material risks associated with investing in DST properties and real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal.

Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated. Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.

Securities offered through Concorde Investment Services, Inc. (CIS), member FINRA/SIPC. Insurance offered through Concorde Insurance Agency, Inc. (CIA) Halston Pacific is independent of CIS and CIA.

 

Do You Need to Be an Accredited Investor to Complete a 1031 Exchange?

It’s no secret that some investment options are confusing. While doing your research, you may come across terms you’re not familiar with. For example, many real estate investments are open to “accredited investors” only. What does this mean, and how does it apply to 1031 exchanges? The following guide will tell you everything you need to know.

What is an Accredited Investor?

The term “accredited investor” was created by the Securities and Exchange Commission (SEC) to describe a certain type of sophisticated investor. It’s defined under Rule 501 of Regulation D in the Securities Act of 1933.

To qualify as an accredited investor, you must meet the following requirements:

1. Earn an annual income of at least $200,000 (individual) or $300,000 (joint) in the past two years. 

2. Have a net worth of more than $1 million (excluding the value of your primary residence), either individually or with your spouse.

You must also reasonably expect to maintain the same levels of income in the future. Due to their financial success and presumed experience, accredited investors are considered sophisticated. It’s assumed that they have enough experience to understand complex investment vehicles.  

Rule 501 also defines accredited investor status for organizations. This includes trusts, companies, and other entities.

Why Are Some Investments Restricted to Accredited Investors? 

Under normal circumstances, investment securities must go through a registration process before they’re offered to the public. This is intended to protect investors from getting involved in securities that are fraudulent, overly-complex, or illiquid. However, the registration process can create a financial burden for investment companies. For this reason, there are many exceptions that allow issuers to avoid registration.

If a company wants to avoid having to register its offerings, they often must agree to limit their sales to accredited investors only. The SEC assumes that individuals who have reached accredited investor status are capable of thoroughly evaluating an investment offer. This includes determining the merits of the investment and evaluating its potential risks. Only after this evaluation is done can someone truly determine whether an investment is an appropriate choice for their needs. In the event that an accredited investor makes a poor decision, it’s also assumed that they have the means to overcome the negative financial impact.

Unregistered private investments are often complex, have the potential for significant losses, and may not be fully liquid. By limiting the sales of these securities to accredited investors, the SEC is attempting to prevent inexperienced investors from getting in over their heads.

Do You Need to Be an Accredited Investor to Do a 1031 Exchange?

A 1031 exchange is a transaction that allows investors to defer capital gains on the sale of investment property. To qualify for this tax benefit, you must exchange your current property for a “like-kind” property (or properties) of equal or greater value. 

While investors must follow IRS rules to qualify for this favorable tax treatment, they are not required to be an “accredited investor.”

However, if investors use the  Delaware Statutory Trust (DST)  structure for1031 exchange using a Delaware Statutory Trust (DST), that is a different story. 

Because DSTs are considered “securitized investments” by by the SEC, the accredited investor requirement kicks in. DSTs allow multiple investors to own fractional interest in a single property or a portfolio of properties. Like other unregistered investments, DSTs can be complex and are considered illiquid investments.. So, while you don’t have to be an accredited investor to engage in a 1031 exchange, you do if you plan to do it using a DST.

Learn More About 1031 Exchanges

A 1031 exchange offers many advantages for both accredited and non-accredited investors. This includes investment diversification, tax deferral, and the potential for increased cash flow. However, while the concept isn’t complex, the execution can be.

If you’re interested in taking advantage of a 1031 exchange, we can help. Contact us today to discuss your goals and learn how to get started.

We encourage you to find additional insights in our eBook, Top 11 Misconceptions About 1031 Exchanges, which you can download for free HERE

This is for informational purposes only, does not constitute as individual investment advice, and should not be relied upon as tax or legal advice. Please consult the appropriate professional regarding your individual circumstance. Because investors’ situations and objectives vary this information is not intended to indicate suitability for any particular investor. 

 DST 1031 properties are only available to accredited investors (typically have a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last three years) and accredited entities only.  If you are unsure if you are an accredited investor and/or an accredited entity please verify with your CPA and Attorney. 

There are material risks associated with investing in DST properties and real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal.

Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated. Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.

Securities offered through Concorde Investment Services, Inc. (CIS), member FINRA/SIPC. Insurance offered through Concorde Insurance Agency, Inc. (CIA) Halston Pacific is independent of CIS and CIA.

A Beginner’s Guide to 1031 Exchanges

If you’re thinking about selling an investment property, a 1031 exchange could potentially save you thousands of dollars in taxes. Savvy investors often use this strategy to defer capital gains and build wealth. While it’s not difficult to perform a 1031 exchange, there are many moving parts. This makes it critical to ensure you have a solid understanding of the basic rules and requirements before getting started. 

What is a 1031 Exchange?

Section 1031 of the IRS Tax Code allows investors to defer capital gains taxes on a property sale by reinvesting the proceeds of the sale into another “like-kind” property. This transaction is known as a 1031 exchange or a “like-kind exchange.”

Since you’re not paying taxes on the proceeds from your property sale, you’re able to keep more of your money working for you. This gives you the potential to continue growing your real estate investment portfolio at an accelerated rate. 

Qualified Intermediaries

The simplest way to complete a 1031 exchange is for two individuals to swap properties. However, it’s unlikely that you’ll find someone who has a property you want and who also wants the property you have. Therefore, most 1031 exchanges are “delayed exchanges.”

As part of the 1031 exchange rules, the IRS requires that the property owner never takes possession of the sale proceeds. Since the property sale and purchase don’t take place simultaneously, a delayed 1031 exchange requires the assistance of a third party, known as a “qualified intermediary.” 

After you sell the first piece of property, the qualified intermediary holds the proceeds until you find a replacement. When you do, they use the funds to purchase the replacement property for you. When choosing your qualified intermediary, it’s important to note that this party cannot have any other formal relationship with either the property buyer or the seller.

The 1031 Exchange Timeline

When engaging in a delayed 1031 exchange, timing is critical. To ensure favorable tax treatment, you must comply with both the “45-Day Rule” and the “180-Day Rule.”

The 45-Day Rule

The 45-day rule states that you must find a replacement property within 45 days of selling the original property. You must also provide information about the property to your qualified intermediary before the end of the 45-day period. You can designate up to three properties, and in some cases, you may be able to designate more. However, to complete the 1031 exchange, you must ultimately close on one of the properties you’ve designated. 

The 180-Day Rule

While you only have 45-days to find a “like-kind” property, you have a total of 180 days from the sale of the first property to close on your replacement property.

It’s important to note that the 45-Day Rule and the 180-Day Rule run concurrently. In other words, if you take the full 45 days to find your replacement property, you will only have 135 days from that time to close on it.

Eligible Properties

While the 1031 exchange rules require the purchase of a “like-kind” property, there’s actually quite a bit of flexibility. The term “like-kind” refers to the character or nature of a piece of property, not the quality or grade. For this reason, all real property in the United States is considered “like-kind” to other pieces of real property in the U.S.

  • Some examples of the properties you can exchange include:
  • Farmland for a commercial building
  • Multi-unit apartment building for a rental condo
  • Industrial property for retail rental
  • Commercial property for residential property
  • Raw land for improved real estate
  • Oil and gas royalties for a ranch

In addition to being “like-kind,” IRS rules state that both the relinquished and the replacement property must be held by the exchanger for investment purposes or for productive use in a business or a trade. A property that is held primarily for sale would not qualify for favorable tax treatment under section 1031.

1031 Exchange Benefits

Deferring capital gains taxes is the number one advantage of a 1031 exchange. Deferring taxes allows you to take advantage of a compounding effect, which can potentially accelerate portfolio growth. While this is the most obvious advantage, there are other important benefits you may recognize when completing a 1031 exchange.

Ability to Exchange Out of Undesirable Assets

Completing a 1031 exchange gives investors the option to exchange underperforming or undesirable real estate assets for a more appealing piece of real estate. Property owners who want to move away from time-consuming active management also have the option of using an investment vehicle known as a Delaware Statutory Trust (DST) in lieu of purchasing another piece of real property. The flexibility to choose from a wide variety of replacement assets is an important advantage for many investors.

Greater Diversification

The ability to easily switch from one type of property to another also provides the potential for additional diversification. For example, an investor holding a single managed property can complete a 1031 exchange into a variety of passive investments. This allows them to reclaim the time they were spending on property management and spread risk across several different markets.

Ability to Build Equity Over Time

There’s no limit to the number of times you can complete a 1031 exchange, so it’s possible to continually roll your real estate gains over from one investment property to the next. Each time you trade up, you have the chance to build more equity. An investor who starts out with one single-family rental property can use a 1031 exchange to upgrade to a duplex, then a fourplex, and so on. Using this strategy is an excellent way to build a large portfolio of real estate assets.

If you continue exchanging properties for long enough, when you ultimately sell, you’re also likely to be taxed at the long-term capital gains rate. This will result in additional tax savings. 

Additional Exit Flexibility

By exchanging a single investment property for multiple smaller properties, investors can take advantage of the ability to sell portions of their real estate portfolio over time instead of all at once. This creates additional flexibility and freedom.

Potential Risks to Consider

While a 1031 exchange offers many potential benefits, it’s also important to consider the possible drawbacks. Failing to keep the following risks in mind can result in a transaction losing its qualification as a 1031 exchange. This will likely lead to a large tax liability.

Tight Timelines

The IRS very rarely allows for extensions of the 45-day and 180-day rules. Investors who fail to meet these deadlines will lose their opportunity to enjoy the benefits of a 1031 exchange. If you’re not confident you’ll be able to locate a replacement property within 45 days and close within 180 days, then a 1031 exchange is not your best option.

Difficulty Finding “Like-Kind” Properties

While investors have a lot of flexibility in choosing replacement properties, the tight timeline may make it difficult to find one that’s suitable. It’s important that your replacement property meets your long-term investment goals.  The last thing you want to do is settle for an undesirable property or one that will give you subpar performance because you’re scrambling to meet the required deadlines. 

Taxation on “Boot”

To get the full advantage of a 1031 exchange, you’ll want to purchase a replacement property that costs the same amount or more than the relinquished property. If there’s money left over after the exchange is complete, the qualified intermediary will pay it back to you. This cash is called “boot” and it is taxed as capital gains.
Investors also sometimes forget to consider loans they’ve taken out on the property. If you don’t get cash back but your new mortgage is lower than the mortgage on the relinquished property, this is another form of boot. It’s taxed the same as if you had received cash. If you do this, you’ll need to make sure you have enough liquidity to pay your tax liability. 

Reduced Tax Basis

A 1031 exchange reduces the replacement property’s tax basis by the amount of the deferred gain. This means that when you ultimately sell the property without doing an exchange you’ll have to pay taxes on the gains you had previously deferred. 

Future Uncertainty

While deferring taxes sounds appealing, it’s important to remember that the future is uncertain. There’s a chance that capital gains tax rates could be significantly higher when you ultimately sell your property. Many investors are comfortable taking this risk, but it’s still important to consider.

Conclusion

We hope you’ve found this guide helpful. Now that you know all the basics of a 1031 exchange, you’re in a better position to decide whether it’s the right strategy for you. As long as you’re comfortable with the potential risks, there are many benefits and opportunities associated with a 1031 exchange.

It’s important to note that the information in this material is not intended as tax or legal advice. Before you make your final decision, it’s important to discuss your property exchange strategy with both a financial advisor and a tax professional. 

We encourage you to find additional insights in our eBook, Top 11 Misconceptions About 1031 Exchanges, which you can download for free HERE

This is for informational purposes only, does not constitute as individual investment advice, and should not be relied upon as tax or legal advice. Please consult the appropriate professional regarding your individual circumstance. Because investors’ situations and objectives vary this information is not intended to indicate suitability for any particular investor. 

 DST 1031 properties are only available to accredited investors (typically have a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last three years) and accredited entities only.  If you are unsure if you are an accredited investor and/or an accredited entity please verify with your CPA and Attorney. 

There are material risks associated with investing in DST properties and real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal.

Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated. Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.

Securities offered through Concorde Investment Services, Inc. (CIS), member FINRA/SIPC. Insurance offered through Concorde Insurance Agency, Inc. (CIA) Halston Pacific is independent of CIS and CIA.

Be Very Careful Before Taking Cash Out of Your 1031 Exchange!

I was recently introduced to a wonderful couple by Ron, a Qualified Intermediary colleague who knew I would be able to help them with their 1031 exchange which was valued at approximately $3 million. Ron said, “Herb, you are going to love these folks. Their parent bought investment property years and ago and built up a nice nest egg for retirement. The income from these properties help them put their children through school and get them started on the careers, debt free. They really did it the right way!”

I followed up with them right away and was intrigued by their backgrounds and history. Esteban Ramirez and his wife Monica Yee both came from immigrant families to the US.  Esteban was born in Indiana after his parents immigrated to the US from Mexico and Monica was a naturalized citizen from China.  Her mother and father came to the US to study at Stanford and UC Berkeley, respectively when she was two years old.  Esteban and Monica met in college at UCLA.

Both sets of  parents had invested in real estate and Monica had been managing her father’s real estate since he passed in 2009.  When I spoke to Esteban and Monica, I learned that their children were in college and one had married in 2017 and just had their first child. Esteban and Monica wanted to slow their lives down a bit and spend more quality time with their grandchild. They had been prodding their other children to move-it-along as they told me . . . meaning get married and give us more grandchildren!

The Ramirez’s had recently sold two investment properties around $2.89M, were in escrow to buy one rental at $700K and wanted to place the balance of the proceeds into a variety of Delaware Statutory Trust (DST) investments. DSTs, as you have heard me mention before, are a popular option for 1031 exchangers because they are passive investment which allow investors to rid themselves of the hassles of property management.  Ron, their QI, had told them of the DST option, and after my conversation and several ZOOM calls with several sponsors, they realized that this was the right approach for them.

As I was doing my discovery work with the sponsors, I received a statement from the QI in the amount of $1,418,000. Knowing the value of investment properties they sold, the numbers clearly did not add up.  When I asked Esteban and Monica about the discrepancy, they mentioned there was a small $200,000 loan on one of the properties and at the close of escrow they decided to immediately receive $572,000 to that off along with some other expenses.   Unfortunately, they did not realize the full ramifications of this decision.  I think it was my silence and slightly audible groan.  Receiving $572,000 as cash did not put the full 1031 exchange in jeopardy, but it had now become a partial 1031 exchange and the $572,000 was subject to capital gains taxes.  “Did we screw something up?,” he asked me.

I explained to them the reason why ALL proceeds from a property sale in a 1031 Exchange must be immediately received by the QI at the time of closing the sale. The seller can never take receipt of the funds or the 1031 exchange rules will have been violated.  In the case of Esteban and Monica, their QI did explain this to them, but they did not contact their CPA or Tax Attorney prior to closing the sale which they were advised to do. As it turns out Esteban and Monica were not ignoring their QIs advice. Esteban’s mother had been having some health problems, and among other things, they simply got too busy.

This is why I stress how important it is to to bring all the important players together – your CPA, Tax professional, Financial Advisor and Qualified Intermediary at the very early stage of your 1031 exchange. These are the professionals that will help keep you on track and help ensure your exchange is successful. If Monica and Esteban had put their team together early in the sale process, they possibly could have saved over $150,000 in taxes.

Although, disappointed, they kept a positive attitude.  Esteban assured me emphatically, “We will not take a single step on the sale of our other properties before talking to you and our CPA!”

We trust this discussion has been helpful, and we encourage you to find additional insights in our eBook, Top 11 Misconceptions About 1031 Exchanges, which you can download for free HERE

This is for informational purposes only, does not constitute as individual investment advice, and should not be relied upon as tax or legal advice. Please consult the appropriate professional regarding your individual circumstance. Because investors’ situations and objectives vary this information is not intended to indicate suitability for any particular investor. 

 DST 1031 properties are only available to accredited investors (typically have a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last three years) and accredited entities only.  If you are unsure if you are an accredited investor and/or an accredited entity please verify with your CPA and Attorney. 

There are material risks associated with investing in DST properties and real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal.

Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated. Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.

Securities offered through Concorde Investment Services, Inc. (CIS), member FINRA/SIPC. Insurance offered through Concorde Insurance Agency, Inc. (CIA) Halston Pacific is independent of CIS and CIA.

1031 Exchanges are Complicated and Only for Big Investors

I have had the good fortune to work with many clients who purchase real estate investment property as a strategic part of their overall financial plans. As both a licensed investment professional and experienced real estate broker, I believe owning income-producing real estate is an excellent strategy for clients seeking broader portfolio diversification beyond just stocks and bonds and alternative sources of income potential.

Surprisingly, however, when introduced to the concept of the 1031 exchange as a tax efficient approach to selling and purchasing investment property, many eschew this approach, believing it is too complicated or only designed for big corporate investors. Neither view is entirely accurate.

Too Complex?

Internal Revenue Code Section 1031 enables investment property owners to sell investment property and defer paying taxes if the proceeds from the sale are reinvested in a like-kind replacement property of equal or greater value within certain timelines. If you were a first-time investor and just read that sentence, several questions might immediately come to mind:

  • What is a like-kind property?
  • What are the timelines?
  • What taxes are deferred?
  • What constitutes investment property?

Subsequently, without you knowing the answers to these questions, you might simply assume the 1031 exchange is too complicated for you. But it need not be. While the rules governing 1031 exchanges are well-defined and must be strictly adhered to, a good Qualified Intermediary (QI) can help guide you so that your exchange goes smoothly. The QI plays a vital role in the exchange process and works closely with your tax and legal advisors and your investment professional to help ensure all the boxes are getting checked off properly and in accordance with the rules.

Not for Me?

Are 1031 exchanges only used by big wealthy investors, corporations, or partnerships? In a word, no. The generous tax advantages of the IRC Section 1031 code apply to anyone owning investment property that has a gain or appreciated value (market value greater than its adjusted basis). That means large institutional investors who own and sell commercial office buildings or retail centers, as well as small mom and pop’s who own a single rental property, are enjoying the benefits of 1031 exchanges. 

And according to a recent commentary in Realtor Magazine by  Shannon McGahn, National Association of Realtors SVP of government affairs: 

“Only 5% of exchanged properties are held by corporations, with the majority owned by mom-and-pop investors.1

Further evidence confirming the popularity of 1031 exchanges among individual investors is the fact that use of the Delaware Statutory Trust (DST) structure, which conforms to 1031 exchange rules, continues to grow in volume every year. 2

One reason for that growth can be attributed to the fact that a DST is a passive investment structure, and many investors who have tired of the daily maintenance and management hassles of ownership, are flocking to DSTs, which have already purchased properties and have management teams in place who are responsible for those duties.

According to recent data from Mountain Dell Consulting, this securitized part of the 1031 exchange industry (of which DST’s represent 93% of the volume) raised nearly $3.5 billion in 2019, the second highest yearly volume on record.2 That is a strong indicator that the 1031 exchange business is healthy, demand is growing, and that these tax-advantaged structures are not just for the big guys! 

We trust this discussion has been helpful, and we encourage you to find additional insights in our eBook, Top 11 Misconceptions About 1031 Exchanges, which you can download for free HERE

1 https://magazine.realtor/news-and-commentary/commentary/article/2020/07/commercial-real-estate-needs-help-stabilizing  

2 https://thediwire.com/1031-exchange-programs-raise-3-5-billion-in-2019/ 

This is for informational purposes only, does not constitute as individual investment advice, and should not be relied upon as tax or legal advice. Please consult the appropriate professional regarding your individual circumstance. Because investors’ situations and objectives vary this information is not intended to indicate suitability for any particular investor. 

 DST 1031 properties are only available to accredited investors (typically have a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last three years) and accredited entities only.  If you are unsure if you are an accredited investor and/or an accredited entity please verify with your CPA and Attorney. 

There are material risks associated with investing in DST properties and real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal.

Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated. Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.

Securities offered through Concorde Investment Services, Inc. (CIS), member FINRA/SIPC. Insurance offered through Concorde Insurance Agency, Inc. (CIA) Halston Pacific is independent of CIS and CIA.

Can’t Find a Replacement Property for Your 1031 Exchange? Do Not Panic.

It is quite common. You get an offer on your investment property that is simply too good to pass up. You get it under contract with the intent of using a 1031 exchange to reinvest the proceeds from the sale and defer what would otherwise be a huge capital gains tax obligation. 

Because your property has appreciated so much in value, you can now purchase a larger investment property through your exchange and hopefully, increase your monthly income significantly. Everything is looking great. You close on your sale. Congratulations! All you need to do now is find the right replacement property.

But within days, you begin to realize that that is going to be a very challenging task to complete within the 45-day window allotted by 1031 exchange rules. 

  • The pandemic is limiting your ability to identify, inspect and properly value replacement properties.
  • Lenders have made the loan approval process more laborious as they await what many believe will be a wave of defaults. 
  • And even sellers, skittish about how slowly the economy may rebound, are pulling properties off the market.

All of a sudden, the joy you felt in selling your property at the top of the market, is gone. And now, the IRS is the one that stands to benefit greatly as your tax-deferral benefit vanishes. If only there was a way to save your exchange!

DST as a Backup

Fortunately, there is an investment alternative which complies with 1031 exchange regulations and it has been used to save many investors who have found themselves living the nightmare described above. It is called The Delaware Statutory Trust (DST) and can be used by suitable exchangers up against their 45-day deadline to identify up to three potential replacement properties.

How does the DST enable investors to side-step the challenges they might encounter with a traditional 1031 exchange like those mentioned previously? It does so because it is structured differently. For example:

  • The sponsor of a DST has already identified a property that will be held. 
  • Due diligence work, financial evaluation and inspections have occurred, and the property has been purchased. 
  • If leverage was needed, loans have already been secured. 
  • And finally, a professional management team has been selected and is managing the property currently.

So, for 1031 exchange investors, they are able to preview and select a replacement property that is already operating and generating potential revenue. DSTs can also serve as excellent back-up properties should 1031 exchangers be unable to close on the new property within the 180-day period after close on the relinquished property. Investors can often close on a DST in just a few days.

A Few Added Benefits

Beyond the ability of the DST to help investors meet their replacement property identification requirements, DSTs also offer a few additional advantages that 1031 exchangers may not be aware of, including:

  • The ability to diversify their portfolio among different property types, in different locations throughout the U.S.
  • The ability to offload the headaches of personally managing an active property to a professional management team
  • The ability to own fractional interest in a property that can be divided equally among heirs for when an estate is settled
  • Exchangers don’t have to go through the qualification process of obtaining a loan

If you are considering a 1031 exchange, we hope this discussion has been helpful on how you can help yourself should you encounter some of the challenges others like you have experienced. 

Please feel free to contact me for more information. You can also download my latest Ebook, The Top 11 Misconceptions about 1031 Exchanges.

This is for informational purposes only and does not constitute an offer to buy or sell an investment. Because investors situations and objectives vary this information is not intended to indicate suitability for any particular investor.  DST 1031 properties are only available to accredited investors (typically have a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last three years) and accredited entities only.  If you are unsure if you are an accredited investor and/or an accredited entity please verify with your CPA and Attorney. There are material risks associated with investing in DST properties and real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal.

Securities offered through Concorde Investment Services, Inc. (CIS), member FINRA/SIPC. Insurance offered through Concorde Insurance Agency, Inc. (CIA) Halston Pacific is independent of CIS and CIA.

How a Webinar Helped an Agent Sell a House That Was Sure to be Re-Rented

The DST helped once again to be a realtor’s deal saver.

Sometimes we discover an immediate solution when we were least expecting it. I recently held a webinar for real estate agents where I discussed in detail the advantages of the 1031 ‘like-kind’ exchange structure for investment property owners considering a sale. Most realtors I know have a basic understanding of the 1031 exchange and recognize it as a transaction that enables sellers to defer capital gains tax.

But, as one attendee discovered in our webinar, the Delaware Statutory Trust (DST) is also considered a like-kind exchange by definition in the Internal Revenue Code and it has been used to help save many real estate deals that looked like they were falling apart. Here is a story of how one realtor with 35 years of experience learned about the DST and turned a diminishing opportunity into a property listing and sale.

The real estate agent (Joe) had a potential client (Carol) who had owned a rental property for years. It had recently been vacated by a long-term tenant and she was preparing it to be rented again. Her other choice was to sell the property. Carol faced challenges with either option.

As a widow on a fixed income, she relied on the income her rental generated. But she was tiring of the sole obligations that go along with managing and keeping up a rental property, and since her sons both lived out-of-state she would have to continue to own that responsibility if she re-rented. On the other hand, if she elected to sell the property, her estimated capital gains tax bill would be north of $100,000 which would reduce the amount she would be able to reinvest. And that reinvestment would likely be in the markets where she may not be able to get the same returns she had enjoyed with the rental. Neither option looked great to her.

Fortunately, Joe had recently attended one of my webinars where I had discussed the DST as an optional structure for suitable owners interested in selling a property and reinvesting in another. Joe found the DST to be immediately appealing because it would enable Carol to sell her property, avoid capital gains tax liability and to reinvest the entire proceeds from the sale into a passive investment where she would have no management responsibilities and have the potential to earn more income that she could in the market.

Joe mentioned this option to Carol, and she called me shortly thereafter. I explained how the DST works and the variety of different property types and geographic locations she would be able to choose from with this investment. Carol was very astute and asked great questions. She also consulted with her sons, whom I had conversations with as well. Collectively, they decided that selling her rental property and using the DST structure for a 1031 exchange was a suitable solution.

For Joe, not only was he able save a sale, he learned how a DST may help clients who are facing similar choices on what to do with rental properties that have lost tenants. In fact, looking back over his long and distinguished career at a real estate agent, Joe realized how few investment property owners are even aware of the 1031 exchange/DST option. Armed with a new arrow in his quiver, Joe has already identified two new prospects for which the DST could be a suitable solution. And all this from simply attending my webinar.

Please contact me at any time at 415-991-1031 to find out about upcoming events! Make sure to download my latest Ebook, The Top 11 Misconceptions about 1031 Exchanges.

This is for informational purposes only and does not constitute an offer to buy or sell an investment. Because investors situations and objectives vary this information is not intended to indicate suitability for any particular investor.  DST 1031 properties are only available to accredited investors (typically have a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last three years) and accredited entities only.  If you are unsure if you are an accredited investor and/or an accredited entity please verify with your CPA and Attorney. There are material risks associated with investing in DST properties and real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal.

Securities offered through Concorde Investment Services, Inc. (CIS), member FINRA/SIPC. Insurance offered through Concorde Insurance Agency, Inc. (CIA) Halston Pacific is independent of CIS and CIA.

Considering an Investment Property Sale and Wondering if a 1031 Exchange is Worth It?

That Capital Gains Tax May be a Lot Bigger Than You Think.

In my eBook, The Top 11 Misconceptions About 1031 Exchanges,“ the #5 misstep reads: “The capital gain tax rate is only 15%. I’ll just bite the bullet and pay the taxes now.” To which I respond in similar fashion to famed sportscaster Lee Corso of College Gameday . . . “Not so fast my friend!” If you own real estate investment real estate and are considering a sale and you are debating whether you should just take the capital gains tax hit on your appreciated value or defer those taxes with a 1031 exchange, this post may help make your decision easier.

To start off, I believe it’s generally smart to view a 1031 exchange as an investment structure first, and as a tax-deferral strategy second. Why? Because the owner who intends to sell an investment property has unique reasons for selling. It could be that he or she wants the cash proceeds to use for another purpose. Or may just not want to own investment real estate any longer. In either case, deferring taxes is not a motivation, so a 1031 exchange usually isn’t a consideration.

On the other hand, if you are an investment property owner thinking of a sale and wondering if the tax deferral benefit of a 1031 exchange is advantageous enough to outweigh your desire to simply receive the cash (even knowing that amount will be reduced by capital gains tax), you have some other tax issues to consider. First, know that capital gain tax rates change with some frequency and depending on your income and marital status, your capital gains tax rate currently might be 0%, 15%, or 20% but can go as high as 37%.

But that is not all . . .

The sale of an investment property generally is subject to depreciation recapture tax. This tax is based on your income tax rate and may be as high as your ORDINARY INCOME tax rate, which applies to the portion of the gain attributable to the depreciation deductions you have already taken. In many cases, investment property owners can also defer the state tax on the sale of real estate, so your blended capital gains rate could be as high as 40%. On the sale of a $1 million property, that means walking away with only $600,000 in cash or using a 1031 exchange and reinvesting the full $1 million.

Think about it. You have put in a lot of hard work, courage, persistence, and sweat equity into your property over many years. I don’t know of many investors who would be pleased to send a large percentage of what they earned in appreciation to their “favorite” member of congress to spend, as they see fit.

So, for those investors thinking they might be better off to simply pay the capital gains tax obligation on an investment property sale; it is important to know that the tax hit may be a lot bigger than you think!

But that is not all . . .

There is a confusing part of the tax code called Alternative Minimum Tax (AMT), which actually went away in the 2017 Tax Cut and Jobs Act (TCJA). Don’t get too comfortable in your chair; TCJA kept the AMT but raised the exemption and phase out levels for tax years 2018 – 2025. It will be back in 2026.

There are many other common misconceptions about 1031 exchanges that I encourage you to explore in my eBook which you can download here. You can also contact me at info@1031exchangesite.com.

This is for informational purposes only and does not constitute an offer to buy or sell an investment. Because investors situations and objectives vary this information is not intended to indicate suitability for any particular investor.  DST 1031 properties are only available to accredited investors (typically have a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last three years) and accredited entities only.  If you are unsure if you are an accredited investor and/or an accredited entity please verify with your CPA and Attorney. There are material risks associated with investing in DST properties and real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal.

Securities offered through Concorde Investment Services, Inc. (CIS), member FINRA/SIPC. Insurance offered through Concorde Insurance Agency, Inc. (CIA) Halston Pacific is independent of CIS and CIA.

1031 Exchangers – Do Not Mess with Your Deadlines

Misconception #11 – “45 Days and 180 Days Are Not Written in Stone”

Rules matter. Especially as they pertain to certain requirements of a properly executed 1031 exchange. Believe me, I have seen many hearts broken and financial plans damaged by well-intentioned investors who either did not understand the rules of their exchange or did not think that the rules would be so strictly enforced.

There are several common misconceptions around 1031 exchanges that I highlight in my eBook. But the deadlines an exchanger must meet to identify a replacement property and to complete the exchange have absolutely no wiggle room. Zero.

Let us look at those rules more closely.

First, know this: You cannot manipulate, alter, play with, cajole or in some way change the timelines. If you close escrow on March 1st, your 45th day to declare the replacement property is May 16th regardless if that occurs on a Wednesday, Saturday, or Sunday. The last day that you must clarify the replacement property is always 45 days after the closing of the sold or relinquished property. You must close escrow on your replacement property on the 180th day or your exchange is blown. The first thing to do when you close escrow on your relinquished property is to look at your calendar and mark the 45th and 180th day on your calendar.

To be even more specific, the “closing” on the relinquished property occurs when the deed or transfer document is recorded, and the replacement property identification period ends at midnight on the 45th calendar day following the recording date. Similarly, the 180-day exchange period starts on the recording date.

Any Exceptions?

So, now that I have explained there can be no variance in 1031 exchange timeline rules, we need to note there actually can be exceptions, but only two and they are quite rare.

The first extension is provided to armed services members who are actively serving in a combat zone and this exception is defined in Internal Revenue Code (I.R.C.) Section 7508. The second extension is outlined in IRC 165(h)(3)(c) and is extended to exchangers who find themselves subjected to “federally declared disasters” which are generally determined by the President of the United States.

In addition, a natural catastrophe the President determines to be severe enough to warrant the support of federal resources could also provide time extensions in localized areas to 1031 exchange investors. Examples include Hurricanes Harvey and Maria in 2017 and the California wildfires in 2018.

The COVID-19 pandemic created the most recent exception for exchange timelines when the IRS issued Notice 2020-23 on April 9, 2020, extending additional relief for taxpayers impacted financially by the aftereffects of the virus and shutdown of so much of our economy. The Notice extended the 45-day identification period and the 180-day exchange period for exchangers with deadlines due on or after April 1, 2020. Deadlines for both periods were extended to July 15, 2020. No relief was extended to exchangers whose 45-day or 180-day deadlines fell prior to April 1, 2020.

But, as mentioned earlier, even though there have been (rare) exceptions for the timeline rules, investors using a 1031 exchange to sell an investment property and purchase another should assume the 45-day and 180-day deadlines are written in stone. Follow those rules and you can help avoid having your exchange tripped up.

Download my eBook, The Top 11 Misconceptions About 1031 Exchanges today!

You can also contact me at info@1031exchangesite.com.

This is for informational purposes only and does not constitute an offer to buy or sell an investment. Because investors situations and objectives vary this information is not intended to indicate suitability for any particular investor.  DST 1031 properties are only available to accredited investors (typically have a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last three years) and accredited entities only.  If you are unsure if you are an accredited investor and/or an accredited entity please verify with your CPA and Attorney. There are material risks associated with investing in DST properties and real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal.

Securities offered through Concorde Investment Services, Inc. (CIS), member FINRA/SIPC. Insurance offered through Concorde Insurance Agency, Inc. (CIA) Halston Pacific is independent of CIS and CIA.