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May 24th, 2017 by FGG

HOW DSTs CAN PREVENT A FAILED 1031 EXCHANGE

I received a call from a current client who I will refer to as “Tom” at 4 pm on Good Friday afternoon while I was driving up to spend time skiing with friends at Lake Tahoe the following day. Tom indicated that he had just lost an opportunity to acquire a replacement property for a pending 1031 Exchange and that his 45thday was the very next day.He further shared that he was facing a large tax liability if he could not immediately identify a suitable property and asked for my assistance. Fortunately, we had discussed DST investment options several weeks earlier. While Tom was aware of DST benefits and tradeoffs, he had decided to move forward to acquire a single replacement property. At the time we first talked, he was so certain that could close on the property that he did not see a need to identify any back-up options.

 

After conferencing in our office personnel on the phone call, we were able to match up several DST options that fit Tom’s objectives and sent him offering materials which he was able to review beginning that evening. He made a final selection on Saturday and we assisted him in completing his identification paperwork in time to meet his 45-day deadline thereby saving him a six-figure tax bill.  

 

Unfortunately, we receive many calls from investors who, like Tom, were unable to obtain a preferred replacement property and then find themselves in a panic to find an alternative investment property before they run out of time. 

 

Here are the main reasons we encourage all 1031 Exchange clients to list at least one DST property as a back-up option:

 

  • 100% Certainty to Close: Because DSTs are pre-packaged, “ready-to-invest” properties, with no loan qualifying required, there is minimal risk that a selected DST will not be available to complete the Exchange.  Unlike traditional real estate, investors are not competing with other investors to obtain the investment and are not subject to financing contingencies.  
  • Well Documented Due Diligence: Since DSTs are securities, the available documentation and disclosures are sufficiently comprehensive that most investors evaluate and select investments without investing the added time to visit the property. While investors always do have the option to visit properties (and many sponsors reimburse travel costs if an investment is concluded), DST due diligence materials provide added information and data that can spare investors the need to conduct a site visit.
  • Little Downside: There are generally no costs associated with reserving a DST 1031 property. If an investor chooses to not move forward, there will be no fees owed to FGG or other intermediaries involved in the transaction.
  • Maximize Tax Deferral: In many 1031 Exchanges, exchange proceeds do not exactly match selected replacement properties and there may be excess gains that cannot be deferred resulting in “boot” or added taxes. Since DSTs are available in a wide range of loan-to-values with minimum investments to $25K, they can be mixed and matched with traditional real estate investments to soak up boot and minimize taxes. 

 

Even if you are certain that your preferred replacement options will close, it may make sense to add a suitable DST back-up option to your list of identified properties in order to reduce potential anxiety and a tax bill.

FGG Admin

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Disclosures

There is no guarantee that any strategy will be successful or achieve investment objectives. All real estate investments have the potential to lose value during the life of the investments. 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. All financed real estate investments have a potential for foreclosure. Delaware Statutory Trust (DST) investments are commonly offered through private placement offerings and are illiquid securities. There is no secondary market for these investments. Like any investment in real estate, if a property unexpectedly loses tenants or sustains substantial damage, there is potential for suspension of cash flow distributions. Costs associated with the transaction may impact investors’ returns and may outweigh the tax benefits.