Coronavirus is disrupting many exchanges, but DSTs offer solutions

On April 9, 2020, real estate investors who were selling property using a 1031 exchange got some badly needed relief when the IRS issued new guidance extending the 45-day and 180-day deadline requirements to July 15, 2020. Many industry groups had lobbied the IRS and Treasury to issue an extension so that investors who were struggling to find replacement properties or close during the COVID-19 lockdown, would be able to do so and retain their tax deferral benefits. This action certainly helped, but it didn’t solve all the challenges would-be exchangers face amidst the impacts of the coronavirus.

Even though the IRS has granted more time to complete 1031 exchanges, I continue to see three lingering issues that make these transactions challenging.

1. Not every state deems Real Estate as an essential service. With stay-at-home orders common now in most metropolitan areas and with several states identifying real estate and the service provided by realtors as non-essential, investors may not be able to view replacement properties.
2. It’s difficult to have properties inspected. A similar situation exists for investors who want to inspect potential replacement properties. Many inspectors may be denied access, or they simply may not want to risk exposing themselves to the virus.
3. Lenders may be more cautious and slower to extend loans. Many investors leverage their investment properties with debt and the 1031 exchange requires investors to replace the amount of debt they had on their relinquished property with the same amount on the new property. But at a time when so many loans are at risk of default due to the tenant’s inability to pay rent, securing new debt may be difficult.

The Delaware Statutory Trusts to the Rescue

Many of my suitable clients have addressed these additional challenges and moved forward with their property sales by using the Delaware Statutory Trust (DST) structure within 1031 exchange guidelines. The DST can help in two important ways.

• A 1031 exchanger can select a DST as a back-up in the event they are not able to find a suitable replacement property in time. If they can close on their original choice of a replacement property, fine. If not, however, the DST serves as a backstop and enables them to preserve their tax deferral benefits by successfully completing their exchange on time.
  • In my opinion, this may be a perfect opportunity to use the 200% rule, which works like this: The exchanger has a $1M exchange; identifies $2M of replacement property ($1M property + $1M DST). If any portion of the $1M falls out for any reason the DST is already identified, helping to protect the exchange from failure.
• Another scenario is that the DST could be the original choice for the exchanger who has no further interest in managing their own investment property and dealing with all the accompanying headaches. The DST structure allows this investor to select from many different property types in different geographical areas, all professionally managed.

• An added benefit here is there is no need to get a loan. Since a DST already has a loan in place the investor can match their needed replacement debt with the debt already available in the DST. This eliminates the third challenge noted above. Also, know that there are many DSTs that have zero debt for those investors who have an all-cash position in their property.

The DST structure may help investors executing 1031 exchanges sidestep many of today’s other challenges. Because a DST already owns the property or properties, the due diligence, valuation and inspection and purchase have already been completed.

• The management team is already attained.
• The leverage is already in place and is non-recourse to the investor, so replacing debt isn’t necessary.
• And, for the exchanger who happens to be right up against their 45-day identification window, a DST investment can often be structured with DST’s to meet the needs of the exchanger.

If you are an investment property owner and thinking about using a 1031 exchange for the sale of your property, or you are already in the process of executing an exchange, if suitable, this is a great time to consider a DST, and I’d be honored to help you.

Also feel free to download my latest ebook, 11 Misconceptions of 1031 Exchanges today!