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Who Should Invest In The Delaware Statutory Trusts (DSTs)?

Tue, 15 Mar 2022 04:24:09 GMT

Between the pros and cons, there’s a lot to consider...

Just because an investment is fundamentally sound or offers a positive return, doesn’t necessarily make it a good one.

There’s an element of “fit” that must be considered any time a potential investment is evaluated.

From time horizon to risk tolerance, return expectations, and income requirements, every investor has different needs, and the key to finding a good investment is to find one that meets most or all of those needs.

For a certain segment of the investing public, an investment in a Delaware Statutory Trust has the potential to be a good fit and is worthy of consideration.

What is a DST?

A Delaware Statutory Trust is a “legally recognized entity that is set up for the purpose of conducting business. They are formed using a private trust agreement under which real property is held, managed, invested, administered, and/or operated for the purpose of profit.”

Translated casually, a DST is a corporate entity, set up for the purpose of acquiring a specific real estate asset. Potential investors purchase shares in the entity, which entitle them to a proportionate share of the potential cash flow and profits produced by the underlying asset.

Pros and Cons of Investing in a DST

Like any investment, there are pros and cons to consider when evaluating a DST opportunity.

On the positive side, DSTs provide individual investors with a passive investment opportunity in institutional quality assets that they wouldn’t otherwise be able to invest in.

It’s passive because the properties are managed by institutional-quality property management with significant experience and a favorable track record. Additionally, DSTs are available in all asset classes, including some of the most popular ones like multifamily, industrial, and office and they can be used as a useful estate planning tool.

Lastly, and maybe most importantly, DSTs can provide significant tax benefits when purchased in conjunction with a 1031 exchange .

While the DST benefits are impressive, there are some downsides to consider. To start, DSTs are illiquid. They require a holding period of 5-10 years and the market can change significantly over that time.

In addition, DST’s can’t raise new capital once they’re closed, which means that: (1) the properties require higher than usual reserves; and (2) an unexpectedly large capital expenditure like a new roof can erode years of profits.

Further, DST investors have no say in property management decisions. They’re passive investors only and will almost certainly come out on the losing side of a dispute with the property manager.

As these are just some of the cons to consider, investors should ensure they are familiar with all risks before investing.

Between the pros and cons, there’s a lot to consider, which brings us back to the idea of “fit.”

What Types of Investors are DST s a Good Fit For?

Generally speaking, an investment in a DST may be a good fit for an individual that falls into one or more of the following categories:

1. Individuals seeking to be passively involved with their investment

2. Individuals looking for exposure to institutional quality assets with professional management

3. Individuals who have experienced a recent gain on the sale of an asset and are looking to defer the gain from taxes

4. Income investors with a 5-10 year time horizon

Who are these individuals? For the most part, they may be, but are not limited to, business owners, successful investors, executives, doctors, lawyers, and accountants who tend to be a little bit older and established in their careers.

Do You Think a DST Might be a Good Fit for You?

I specialize in helping my clients identify and select real estate investments, including DSTs, that are suitable for their risk tolerance and time horizon.

I’d like to invite you to set an appointment or to attend our next seminar.
You can do so by calling me at 650-282-0477 or by sending an email to amit@get1031properties.com I look forward to hearing from you.

This is for informational purposed only and does not constitute an offer to buy or sell any securitized real estate investments. There are risks associated with investing in Delaware Statutory Trust (DST) and real estate investment properties including, but not limited to, loss of entire principal, declining market value, tenant vacancies and illiquidity. Diversification does not guarantee profits or guarantee protection against losses. Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated. 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. Because investors situations and objectives vary this information is not intended to indicate suitability for any particular investor. This information is not meant to be interpreted as tax or legal advice. Please speak with your legal and tax advisers for guidance regarding your particular situation.

Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC.

Who Should Invest Delaware Statutory Trusts (DSTs)?

Sun, 13 Mar 2022 01:42:28 GMT

Between the pros and cons, there’s a lot to consider...

Just because an investment is fundamentally sound or offers a positive return, doesn’t necessarily make it a good one.

There’s an element of “fit” that must be considered any time a potential investment is evaluated.

For a certain segment of the investing public, an investment in a Delaware Statutory Trust has the potential to be a good fit and is worthy of consideration.

What is a DST?

Pros and Cons of Investing in a DST

Like any investment, there are pros and cons to consider when evaluating a DST opportunity.

On the positive side, DSTs provide individual investors with a passive investment opportunity in institutional quality assets that they wouldn’t otherwise be able to invest in.

Lastly, and maybe most importantly, DSTs can provide significant tax benefits when purchased in conjunction with a 1031 exchange .

Further, DST investors have no say in property management decisions. They’re passive investors only and will almost certainly come out on the losing side of a dispute with the property manager.

As these are just some of the cons to consider, investors should ensure they are familiar with all risks before investing.

Between the pros and cons, there’s a lot to consider, which brings us back to the idea of “fit.”

What Types of Investors are DST s a Good Fit For?

Generally speaking, an investment in a DST may be a good fit for an individual that falls into one or more of the following categories:

1. Individuals seeking to be passively involved with their investment

2. Individuals looking for exposure to institutional quality assets with professional management

3. Individuals who have experienced a recent gain on the sale of an asset and are looking to defer the gain from taxes

4. Income investors with a 5-10 year time horizon

Do You Think a DST Might be a Good Fit for You?

Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC.

4 Things to Consider When Finding A 1031 Exchange Replacement Property

amit@urban.realtor (Amit Urban) — Tue, 27 Oct 2020 23:54:54 GMT

Many Bay Area real estate investors I speak with tell me, "Amit, I want to sell my investment property, but where would I exchange my proceeds into?" I've been working with real estate investors for many years, and I understand their dilemma. Where can Bay Area real estate investors find properties that provide more cash flow potential and aren't management-intensive within the dreaded 45-day identification period that goes by far too fast?

To help navigate the identification process and understand which properties are eligible and meet your investment and lifestyle goals, real estate investors should keep their options open. Think broadly when considering a property for your 1031 exchange . Fortunately, the IRS doesn't consider "like-kind property" to be nearly as restrictive as it sounds. Investors can select from apartment buildings, industrial properties, office buildings, shopping centers, single-family home rentals, Delaware Statutory Trusts , and Single Tenant Net Leased Properties, for example.

Each property type has its unique advantages and disadvantages.

From an investment standpoint, they may seem like they're from different universes. When it comes to 1031 Exchanges, there's no requirement that a single-family rental property must be exchanged for another single-family home. Instead, an investor can trade a single-family home for an apartment building, raw land, or a Delaware Statutory Trust. Investors may have their sights set on a particular property type when commencing the sale of their investment property, but I believe this is an excellent opportunity to broaden your horizons and dig deeper into different types of property to diversify your portfolio.

For 1031 exchange reinvestment, the IRS has laid out specific guidelines on which properties you can consider. First and foremost, your primary residence cannot be used for 1031 exchange reinvestment (unless you convert your property into a rental property - download 5-Steps to convert your primary home to a rental property for maximum tax benefits ). Only properties used for business or investment qualify as "like-kind" for 1031 exchange.

There are four things to consider when identifying replacement property:

Personal Time

• Do investors want properties that provide more margin in their personal life, such as more time with family, traveling or other goals?

• Are there parts of managing rental properties that owners enjoy or don't enjoy? Such as value-add projects, tenant relationships, routine maintenance, and/or management?

Regulation

• Where do property owners anticipate housing regulations to be in the next one or two years?

• What is currently proposed in the state your property is located? And how do these new laws affect property owners' ability to effectively manage their property while meeting their income and lifestyle goals?

Risk

• What is the property owner's investment risk and how has it changed?

• Is all the equity tied up in one property, geography, or asset-class?

• How do rental property owners view liability risk (e.g. tenant risk, lawsuit risk, etc.) associated with our current rental property portfolio?

• How do we mitigate the risk?

Income

• How much income is the property currently earning, and how much would the owner like to own in order to maintain their lifestyle?

• Are there any anticipated changes for more income in the future?

Key takeaways

The 1031 exchange is a tool used by savvy real estate investors to take full advantage of the tax code, leverage, and potential cash flow benefits that investment real estate may provide. Because the execution and nuances of 1031 exchanges can get quite complex, investors new to real estate or the like-kind exchange process should contact qualified tax and real estate professionals to be sure an exchange is properly executed.

Are you interested in learning more? I specialize in helping my clients identify and select DSTs suitable for their risk tolerance and time horizon. If you are interested in learning more about DST investment opportunities , I'd like to invite you to set an appointment or attend our next webinar. You can do so by calling me at 650-282-0477 or by sending an email to amit@get1031properties.com.

This is for informational purposed only and does not constitute an offer to buy or sell any securitized real estate investments. There are material risks associated with investing in 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. Diversification does not guarantee profits or guarantee protection against losses. Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated. Because investors situations and objectives vary this information is not intended to indicate suitability for any particular investor. This information is not meant to be interpreted as tax or legal advice. Please speak with your legal and tax advisors for guidance regarding your particular situation.

Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Get1031Properties is independent of CIS.

The Future of 1031 Exchanges? A 721 UPREIT may be the answer.

amit@urban.realtor (Amit Urban) — Tue, 20 Oct 2020 23:24:05 GMT

Once again, the 1031 Exchange is on the chopping block. Joe Biden has announced that he may get rid of this tax policy that allows owners of rental properties to defer their capital gains when selling a property and reinvesting the proceeds into a new "like-kind" property within a certain period.

This is not the first time the 1031 Exchange was at risk. In 2017, Trump was looking at repealing the 1031 Exchange in the Tax Cuts and Jobs Act. Although the tax reform ultimately spared the 1031 Exchange for investment properties, private property, such as art, airplanes, collectibles, etc., was no longer eligible 1031 Exchanges.

Even though I believe the 1031 Exchange will stay, many of my clients are concerned and want to know their options to plan for this potential change in the tax code.

For those investors that are uncertain about the future of 1031 Exchanges and would like to sell their appreciated asset without paying any capital gains, a 1031 Exchange into a DST with a 721 UPREIT may be a potential option.

What is a DST?

The Delaware Statutory Trust (DST) is a legal entity created and often used in real estate investing that allows multiple investors to pull money together and hold fractional interests in the trust's holdings and assets. Typically, a sponsor organizes a DST by acquiring an institutional-quality property, putting a management team in place, organizing financing, and providing investors with a turn-key investment in a professionally managed property. For more information on DSTs, more information can be found here .

What is a 721 UPREIT?

A DST's typical exit strategy is to sell the property and distribute the proceeds to the investors. However, some sponsors allow investors to elect to roll their proceeds into a REIT through a 721 UPREIT (Umbrella Partnership Real Estate Investment Trust).

A pure 721 Exchange transaction would involve a direct contribution of the investor's real property into the operating partnership in exchange for an interest in the operating partnership. This usually never happens because the REIT managers are generally not interested in most real estate an investor has to offer. As such, most 1031 Exchange investors need to follow a two-step process.

The first step is to sell the relinquished property and structure a 1031 Exchange into fractional ownership institutional-quality real estate, such as a DST. This step completes the 1031 Exchange portion of the transaction.

The second step is for the sponsor to contribute the fractional interest into the operating partnership after a holding period for a certain period, which varies from sponsor to sponsor via a 721 Exchange (tax-deferred contribution into a partnership). As a result, the investor receives an interest in the operating partnership in exchange for his or her contribution of the real estate and is now effectively part of the REIT.

The above description is oversimplified but should give readers the general idea of how a 721 UPREIT may be utilized. Below is an overview of some of the pros and cons of this strategy:

Pros:

• Suitable for investors worried about the future of 1031 Exchanges and want to defer their capital gains taxes.

• Potential diversification once the DST is converted into a UPREIT and added into the REIT Portfolio, which typically has other properties.

• Potentially more liquid, since the investor can sell their shares to the sponsor who purchases at the market price.

Cons:

• Since the investor's share in the property is part of a REIT, they can no longer 1031 Exchange out of the UPREIT into other "like-kind" real estate.

• A sale of their interest in a UPREIT will result in a taxable event, including the recognition of previously deferred capital gain and any depreciation recapture.

This is for informational purposed only and does not constitute an offer to buy or sell any securitized real estate investments. 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. 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.Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated. Because investors situations and objectives vary this information is not intended to indicate suitability for any particular investor. This information is not meant to be interpreted as tax or legal advice. Please speak with your legal and tax advisors for guidance regarding your particular situation.

Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Get1031Properties is independent of CIS.

Download Your FREE Listings of 1031 Exchange DST Properties & Information Kit Today!

Finding The Right 1031 Exchange Replacement Property

joel@coaxconsulting.com (Joel Snyder) — Sun, 29 Mar 2020 20:47:33 GMT

Rules and restrictions that make swift identification of a suitable “replacement” property critically important.

A 1031 Exchange is an IRS approved program that allows individual investors to defer taxes on the profitable sale of a property. The deferral can be one time or indefinite if the exchanges are completed over and over. The program is popular with investors and the potential benefits of utilizing it may be powerful. But, to achieve full tax deferral, there are a series of rules and restrictions that make swift identification of a suitable “replacement” property critically important.

Time and Property Constraints

The importance of identifying a replacement property (the property to be purchased) quickly is driven by two time and property constraints outlined in the IRS code that authorizes the 1031 Exchange:

The Replacement Property must be formally “identified” within 45 days of the date that the Relinquished Property is sold.
The Replacement Property must be “like-kind” to the Relinquished Property, meaning that it: must be in the US; must be “of the same nature or character;” must be “held for productive use in a trade or business or for investment;” and the market value must be greater than or equal to the Relinquished Property.

Real Estate transactions tend to have long lead times and there can be significant competition for the best properties. As such, it can be more difficult to find a suitable Replacement Property - within the 45-day time window - than one may think.

Four Tips to Finding a Suitable 1031 Exchange Replacement Property

These four things can be done to help ensure that a suitable Replacement Property is found within the required time frame.

Prepare - If it is known that a 1031 Exchange is the desired next step when listing a property, prepare ahead of time by starting the search for a suitable replacement early. Remember, the 45-day clock starts ticking when the property is sold so looking before the sale actually occurs buys additional time.
Work with a Knowledgeable Broker - Many real estate brokers, myself included, focus specifically on helping their clients find suitable 1031 Replacement Properties. Over years, they’ve developed specific expertise and relationships that may make the process easier. A good broker can quickly identify suitable Replacement Property options and present them to their client in a short period of time. In addition, they may have access to deals that an individual investor doesn’t.
Cast a Wide Net - 1031 Exchange rules do not place any restrictions on where a Replacement Property is located, as long as it is in the United States. If there is difficulty finding suitable replacement properties in a local market, it may be a good idea to broaden the search criteria to include NNN leased or other commercial properties in the entire state or country. Sometimes there are more opportunities in secondary or tertiary markets that may have the potential to be just as, if not more, profitable than the crowded primary markets.
Get Creative - Finally, there is an alternative option for purchasing a property directly known as a Delaware Statutory Trust ( DST ). It is a tax-advantaged entity that has been identified by the IRS as a “like-kind” investment in a 1031 Exchange.

In some ways, a DST offers several potential advantages over direct ownership because: they provide access to institutional quality replacement assets; have professional management, making them a truly passive investment; are available in all commercial asset classes; have low minimums, allowing owners to potentially diversify their investment; and can be a good estate planning tool because DST’s are easily divisible investments and tax rules allow heirs to inherit the holdings at a stepped-up cost basis.

If considering a DST, it is also important to identify the risks of going this route. For example, the fees involved with a DST may affect the overall return and the required holding period can be 10 years or longer.

Interested in Learning More?

I specialize in helping rental property owners build tailored replacement property portfolios that seek to meet their investment and lifestyle goals, which include 1031 Exchange and DST options.

If you are interested in learning more about 1031 Exchange and/or DST investment opportunities , I recommend downloading my latest eBook here or setting an appointment or to attend our next seminar . You can do so by calling me at 650-282-0477 or by sending an email to amit@Get1031Properties.com.

This is for informational purposed only and does not constitute an offer to buy or sell any securitized real estate investments.

There are risks associated with investing in Delaware Statutory Trust (DST) and real estate investment properties including, but not limited to, loss of entire principal, declining market value, tenant vacancies and illiquidity. Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated. Diversification does not guarantee profits or guarantee protection against losses.

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.

Because investors situations and objectives vary this information is not intended to indicate suitability for any particular investor. This information is not meant to be interpreted as tax or legal advice. Please speak with your legal and tax advisors for guidance regarding your particular situation.

Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Get 1031 Properties is independent of CIS.

Mitigating Regulatory Risk Through Delaware Statutory Trusts

joel@coaxconsulting.com (Joel Snyder) — Thu, 19 Mar 2020 17:43:40 GMT

How does a real estate investor identify and mitigate risk?

Seeking to Mitigate Real Estate Regulatory Risk Through Delaware Statutory Trusts

Allocating capital to a real estate investment involves accepting some level of risk in the hope of achieving a positive return. The more risk an investor takes, typically the wider the potential variation in return. This concept introduces an interesting question… how does an investor identify and mitigate risk?

As part of their due diligence, it is the investor’s responsibility to evaluate the current and/or potential risks associated with purchasing a property. Specific to real estate, common risks types include, but may not be limited to: the risk of defect in the physical structure of the building, the market risk that rental rates move against the owner, the interest rate risk that could make refinancing a property difficult, and the credit risk that a tenant will stop making their payments. While these are critically important, there is an equally significant, but often overlooked risk that should also be considered prior to purchase… regulatory risk.

Regulatory Risk - Defined

Regulatory risk represents the possibility that a property may become less profitable to own or more challenging to manage as a result of changes in the laws and regulations that govern it. Applicable laws may be set or changed at the local, state, or national level and can vary widely from one jurisdiction to another. For example, states like Florida and Texas are widely considered to be “landlord friendly” while states like New York and California are considered to be “tenant friendly.”

At the time of purchase, there may not be any regulatory concerns, but rules can change quickly so it is important to look ahead at potential changes. This is especially true for the state of California.

California Real Estate Laws - What’s new for 2020?

The start of 2020 introduced a landmark tenant’s rights legislation bill and the potential for passage of two more, all of which have the potential to materially impact the way that properties are owned and managed.

California Assembly Bill 1482

Passed in 2019 and effective Jan 1st, 2020, California Assembly Bill 1482 is designed to protect tenants from rising rents by capping annual rent hikes at 5% plus the local rate of inflation per year as measured by the Consumer Price Index (CPI). So, for example, if CPI inflation is 2%, then the rent raise would be capped at 5% + 2% = 7%.

In addition, the bill requires that landlords show just cause, such as failure to pay rent, when attempting to terminate a lease. In some cases, it may even require landlords to provide tenants with relocation assistance or rental waivers.

The bill is applicable state-wide, but doesn’t stop individual municipalities like San Francisco, Mountain View, San Jose or Oakland from implementing their own, stricter, rent control measures.

Future Ballot Measures

In addition to HB 1482, there are two ballot measures currently under consideration that could impose additional rent control measures and raise property taxes.

Rent control advocates are seeking a repeal of the Costa Hawkins bill that: (1) protects a landlord’s right to raise the rent to market rate when a tenant moves out; (2) prevents cities from establishing rent control on units constructed after February 1995; and (3) exempts single-family homes and condos from rent control restrictions. They are looking to replace the bill with a form of “vacancy control,” which caps unit rent - even after a tenant moves out. Lawmakers are currently reviewing petitions for inclusion on the November 2020 ballot.

Prop 13 - already set to be voted on in California’s 2020 primary - is a bill that seeks funding for a state-wide school modernization program through significant increases to property taxes. If passed, landlords will be faced with a difficult decision to either shoulder the burden of higher taxes or pass them on to tenants through the rental increases that are allowable under law.

The net effect for both passed laws and contemplated laws is that it is becoming increasingly expensive to own property in California and returns are falling as a result.

Mitigating Regulatory Risk

In any investment - real estate included - one of the bedrock principles of risk management is diversification. Diversification could mean owning different types of asset classes (office, retail, multifamily) or, in the case of regulatory risk, it could mean owning assets in different locations so as to not concentrate regulatory risk in any one area.

Upon reading that, you may be asking yourself, “I’m just an individual investor, how can I possibly manage multiple properties in multiple locations?”

Diversifying Regulatory Risk Through Delaware Statutory Trusts

A Delaware Statutory Trust ( DST ) is a legally recognized entity set up for the purpose of conducting business. They are formed using a private real estate trust agreement under which real property is held, managed, invested, administered, and/or operated for the purpose of profit.

For accredited investors, a Delaware Statutory Trust is a creative way to diversify a real estate investment portfolio - and mitigate regulatory risk - because it allows for an investment in multiple properties across multiple geographic markets. In addition, a DST is:

Professionally managed by real estate firms who may employ multiple decades of expertise to select and manage what they believe are the best properties for their DST portfolios.
Available in many asset classes (multifamily, office, retail, etc.),
Requires a low minimum investment,
Can be an effective estate planning tool when structured correctly.
A vehicle for tax deferral. When combined with a 1031 exchange transaction, a DST investment can produce tax benefits that aren’t available with other types of real estate investments.

While the potential benefits may be powerful, a DST also comes with potential drawbacks that should be carefully considered, which include, but may not be limited to: (1) they typically require a holding period between five and ten years so they may not be the best fit if liquidity is needed; (2) they aren’t allowed to raise new capital once the asset is acquired, meaning that a large capital expense such as a new roof or HVAC system must be paid for out of operating funds, which can erode years of profits; and (3) investors have no say in property management decisions. Their ownership is strictly passive, and the property manager will emerge victorious in any disagreement.

Summary & Conclusion

Real estate is an inherently risky investment and educated investors - and DST managers - take steps to help minimize risk while maximizing return potential. Prior to making an investment, all potential risks should be evaluated, including regulatory risk, because they can have a material impact on returns.

Because regulatory risk is correlated with a property’s location, one of the ways to help mitigate it is by investing in multiple locations. For individual investors that may not have the desire or resources to construct a multi-location portfolio, when suitable, a creative way to diversify portfolio geography is through the use of a Delaware Statutory Trust.

(1) To compensate for this, DSTs usually allocate a larger than normal amount of funds to capital reserves.

Interested In Learning More?

Are you an investor who is interested in learning more about a DST investment? I specialize in helping my clients identify and select real estate investments that are suitable for their risk tolerance and time horizon. I’d like to invite you to set an appointment or to attend our next seminar. You can do so by calling me at 650-282-0477 or by sending an email at amit@get1031properties.com I look forward to hearing from you.

This is for informational purposed only and does not constitute an offer to buy or sell any securitized real estate investments.

Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Get 1031 Properties is independent of CIS.

Download Your FREE Listings of 1031 Exchange DST Properties & Information Kit Today!

1031 Exchanges: 10 Common Myths Debunked

joel@coaxconsulting.com (Joel Snyder) — Wed, 06 Nov 2019 20:04:06 GMT

By Amit Urban, 1031 Exchanges Explained

For real estate investors fortunate enough to sell their property at a profit, minimizing the resulting tax liability is usually a primary goal. One of the most common ways to do so is through a 1031 exchange, which allows an investor to defer the recognition of a gain and the associated tax bill.

Because completing a 1031 Exchange requires extensive paperwork, specific legal knowledge, and interaction with the IRS, many individuals consider them to be too intimidating or time consuming to consider. In doing so, they are missing out on an opportunity to reduce or defer their tax liability, ultimately building more wealth potential for their families.

With the right support team in place, 1031 Exchanges can be an integral part of an investor’s wealth creation strategy. To support this point, I’m going to use this article to debunk ten of the most common myths associated with 1031 Exchanges. But first, let’s review what a 1031 Exchange is.

1031 Exchanges Explained

A 1031 Exchange is a swap of one investment property for another in an effort to defer the recognition of a gain.

The “1031” in the title refers to a section of the Internal Revenue Service Tax Code that states “...no gain or loss shall be recognized on the exchange of real property held for productive use in a trade or business or for investment if such real property is exchanged solely for real property of like kind…”

In other words, an investor selling a property may defer the taxes associated with their gain as long as they “exchange” into a property of “like kind.”

The fine print of Section 1031 outlines a series of rules and requirements that must be met to complete the exchange correctly. It includes a lot of legal and difficult to decipher language, which can be intimidating and imply that they are difficult to complete. They don’t need to be. Below are 10 common myths associated with 1031 Exchanges debunked.

1031 Myths, Debunked

Myth #1: 1031 Exchanges are just for institutional investors

Truth: There is no specific language that limits 1031 Exchanges to institutional investors only. The only exclusion is outlined in Section 1031(a)(2), which states that gain deferral isn’t available for any property that is “held primarily for sale.” So, this excludes developers who build and sell property and “house flippers” but anyone who holds property “for productive use in a trade or business or for investment” is eligible.”

Myth #2: “Like kind” means that a property has to be exchanged for the exact same type of property (e.g., retail for retail)

Truth: No. Real property can be exchanged for any other type of real property as long as it is held “for productive use in a trade or business or for investment.” Section 1031 makes no distinction between property types so, for example, a retail property could be exchanged for a multifamily property. This includes exchanges from a solely owned property into a Delaware Statutory Trust , or DST , if suitable.

Myth #3: ALL funds from the sale of the property must be reinvested

Truth: An investor may choose to reinvest all, or a portion, of their sale proceeds into the new property. However, any proceeds not invested are considered to be “boot” and may be taxable. To pay the taxes, investors may use funds from a variety of sources, including the equity in their home.

Myth #4: Sale of the old property and purchase of the new property must happen simultaneously

Truth: No. Section 1031(a)(3) states that a new property must be identified within 45 days of the sale and the purchase transaction must be completed within 180 days.

Myth #5: 1031 Exchanges are too complicated

Truth: It is true that 1031 Exchanges require adherence to specific rules and a lot of paperwork, which can be complicated. However, working with a real estate professional specializes in working with investors and is familiar with 1031 Exchanges can help one understand the process.

When choosing a Qualified Intermediary (QI), remember that there aren’t very many regulations that govern them. Conducting thorough due diligence to ensure potential intermediaries are capable and reputable is critical to the success of the transaction.

Myth #6: Attorneys can handle the 1031 exchange paperwork

Truth: Not always. Under section 1031(k)-1(k)(2)(i), an attorney may not assist in the transaction if they’ve provided non-exchange related services to the investor within the 2 years prior to the closing of the sale.

Myth #7: To complete a 1031 Exchange, all you need to do is file the paperwork with the IRS

Truth: There are several forms that needed to be filed with the IRS to report the 1031 Exchange; however, it isn’t just a matter of “checking a box.” All aspects of the transaction must be reported correctly, on the correct forms, or the exchange may trigger a taxable event. Again, hiring a Qualified Intermediary can assist in streamlining the paperwork.

Myth #8: A property must be held for a certain period of time before exchanging it

Truth: The language in section 1031 doesn’t specify a time requirement, only that the property be held for “productive use in a trade or business or for investment.” However, the IRS has issued subsequent guidance to indicate that a period of two years would be sufficient to prove a property was held for investment. So, if a property was acquired immediately before the attempted exchange or disposed of immediately after, it may be disqualified and taxable.

Myth #9: It is easy to find replacement properties

Truth: In most cases, real estate transactions involve long lead times. Depending on the desired property type, location, price, and return potential, identifying a suitable property within 45 days may prove to be challenging. To ensure that the required timeline is met, it’s best to work with a knowledgeable broker to identify the most suitable opportunities.

Myth #10: The properties must literally be “exchanged”

Truth: The word “exchange” implies that some sort of property swap must take place. In reality, there are two distinct phases to the transaction, a sale of the “old” property and the purchase of a “new” property.

Interested in learning more about 1031 Exchanges?

I specialize in helping my clients identify and select 1031 Exchange or DST properties that are suitable for their risk tolerance and time horizon. If you are interested in learning more about 1031 Exchange and/or DST investment opportunities , I’d like to invite you to set an appointment or to attend our next seminar . You can do so by calling me at 650-282-0477 or by sending an email at amit@Get1031Properties.com.

This is for informational purposed only and does not constitute an offer to buy or sell any securitized real estate investments. There are risks associated with investing in Delaware Statutory Trust (DST) and real estate investment properties including, but not limited to, loss of entire principal, declining market value, tenant vacancies and illiquidity. Diversification does not guarantee profits or guarantee protection against losses. Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated. 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. Because investors situations and objectives vary this information is not intended to indicate suitability for any particular investor. This information is not meant to be interpreted as tax or legal advice. Please speak with your legal and tax advisors for guidance regarding your particular situation. Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC.

DST: Solution for Aging Rental Property Owners?

joel@coaxconsulting.com (Joel Snyder) — Wed, 06 Nov 2019 19:16:53 GMT

You’ve experienced material price appreciation in your holdings and are at an age where: (1) you’re tired of actively managing your properties; and (2) you’d like to enjoy the fruits of your success.

Except for four recessionary periods, the United States economy has experienced significant growth since July of 1980. If you’ve been a real estate investor for any length of time during this expansion, odds are that you’ve experienced material price appreciation in your holdings. If you started investing towards the beginning of the expansion, you might also be at an age where: (1) you’re tired of actively managing your properties; and (2) you’d like to enjoy the fruits of your success.

For individuals who find themselves in this situation, when suitable, there are two common options to consider:

1) Sell the property and pay the taxes:

Selling the property allows the owner to realize their gains, but it also comes with an unpleasant downside, a big tax bill. In 2019, the top federal capital gains tax rate is 20% depending on income and filing status (it may be higher in certain states such as NY and CA). (1) Because this is significant, many investors are driven to consider ways to defer taxes on their gain, which creates a second option;

2) Sell the property and reinvest the proceeds via a 1031 exchange :

With this option, the property is sold in the same way as option #1, but the proceeds are reinvested into another property using something called a 1031 exchange. Under section 1031 of the Internal Revenue Code, gains on a property may be deferred, allowing the owner to redeploy the capital that would have been paid in taxes, as long as they are reinvested into a property of “like-kind” within 180 days of the sale date. (2) A 1031 exchange is a great solution for the tax issue, but it doesn’t take care of the active management problem, which can be time-consuming and stressful. For investors nearing retirement age and looking to generate more potential income, this is likely something that they just don’t want to deal with.

Luckily, there is an alternative option that seeks to solve both the tax issue and the active management issue while potentially generating more income and providing individual investors with access to institutional quality assets that they wouldn’t otherwise be able to invest in. It is called a Delaware Statutory Trust (DST) and the purpose of this article is to provide an overview of the DST option and to explain how it may benefit a specific type of investor.

What is a Delaware Statutory Trust?

A Delaware Statutory Trust is “a legally recognized entity that is set up for the purpose of conducting business. They are formed using a private trust agreement under which real property is held, managed, invested, administered, and/or operated for the purpose of profit.” (3)

In August of 2004, the Internal Revenue Service ruled that “a taxpayer may exchange real property for an interest in a Delaware Statutory Trust without recognition of a gain or loss under section 1031, of the other requirements of 1031 are satisfied.” (4) For an investor with significant gains and SEC accreditation (net worth of $1MM or an annual salary of $200K or more for the past 2 years)5, this ruling created an attractive replacement option:

3) Sell the property and reinvest the proceeds into a Delaware Statutory Trust (DST):

Similar to option #2, the investor sells their property, but instead of reinvesting the proceeds into traditional real estate, the proceeds are invested into Delaware Statutory Trust. This investment solves both issues; because of the aforementioned IRS ruling, gains are deferred under section 1031, and because a DST is professionally managed, the investor doesn’t have to worry about a late-night phone call or an unexpected repair bill.

What are the potential advantages of investing in a Delaware Statutory Trust?

In short, a DST provides all of the benefits of owning real property, but without the hassle of managing it.

DSTs are managed by best in class real estate firms who use their decades of expertise to select institutional quality assets and make them available for investment through the DST structure. They take on the burden of identifying, analyzing, and purchasing high-quality real estate assets and eliminate the headache of actively managing them.

In addition to offering high-quality assets without the management headache, DSTs offer a host of other potential benefits:

They are available in all asset classes, including retail and multifamily, retail, office, industrial, student housing and self-storage.
They have low minimum investments, allowing investors to diversify by mixing and matching their sales proceeds;
They can be used as an estate planning tool since the investment is easily divisible by heirs and allows them to inherit it at a stepped-up cost basis;
May potentially offer investors more income compared to what they are currently making. DSTs usually activate the idle equity trapped in many Bay Area properties, with returns historically ranging from 5-7%.
Lastly, with a new deprecation schedule, many investors can shelter more income from taxes, allowing DST owners to keep more money in their pockets when compared to their current rental property.

Are there any drawbacks?

Despite the numerous DST potential benefits, they may not be a proper fit for all investors. There are a few drawbacks to consider which include, but are not limited to:

DST investments are illiquid and usually require a holding period of 5-10 years.
DST investors have no control over property management decisions. If there is a management strategy disagreement between the investor and manager, the manager always wins.
Per IRS requirements, a DST may not raise new capital once the fund is closed. As such, a big-ticket repair such as a roof or HVAC system has the potential to erode years of profits1. Because of this, adequate reserves are essential to the successful operation of the DST.
Interest rates and/or the overall real estate market may impact the overall return
Fees and expenses charged by the manager may potentially offset the investment return

Although DSTs are popular, the risks are real and investors could potentially lose some or all of their money. An investor should carefully consider all the risks before investing and evaluate their suitability before finalizing a DST investment.

What should I do if I’m interested?

I specialize in helping my clients identify and select DSTs that are suitable for their risk tolerance and time horizon. If you are interested in learning more about DST investment opportunities , I’d like to invite you to set an appointment or to attend our next seminar . You can do so by calling me at 650-282-0477 or by sending an email to amit@get1031properties.com.

Footnotes

1 - IRS Topic 409 - Capital Gains and Losses

2 - Section 1031

3 - Delaware Statutory Trusts - Wikipedia

4 - IRS Revenue Ruling 2004 - 86

5 - SEC Accreditation defined under Rule 501 of Regulation D

Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC.

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Sheltering Rental Property Income: The Magic of Depreciation

joel@coaxconsulting.com (Joel Snyder) — Fri, 01 Nov 2019 16:54:09 GMT

How expensing depreciation reduces the taxable income of the property
By Amit J. Urban

From income to price appreciation, a real estate investment is chock full of potential benefits related to appreciation. However, one of the most commonly overlooked, but equally as powerful, benefits is the favorable tax treatment created through depreciation.

What is Depreciation?

Just like any tangible asset, real estate tends to degrade over time. What was once a gleaming new property will slowly wear out, succumbing to things like weather, changing tastes, and degradation of major systems like HVAC, Electrical, and Plumbing.

To account for this, the accounting rules that govern real estate allow for a gradual reduction in the value of the property in a process known as depreciation. Officially, depreciation is defined as the accounting method of allocating the cost of a tangible asset over its life expectancy. It represents how much of an asset’s value has been used up and is found as a line item on the income statement. , (1,2)

Why It Matters

Depreciation is beneficial because it’s recorded as an expense line item on the income statement, even though it doesn’t represent cash out of the owner’s pocket. Expensing depreciation reduces the taxable income of the property, creating a smaller tax bill in the process. Consider the following example:

Property #1 - No Depreciation Property #2 - Depreciation

Income $100,000 Income $100,000

Taxes $20,000 Taxes $20,000

Insurance $8,000 Insurance $8,000

Utilities $12,000 Utilities $12,000

Depreciation $10,000

Total Expenses $40,000 Total Expenses $50,000

Net Operating Income $60,000 Net Operating Income $50,000

Both properties have the same amount of income, but property #2 lists $10K in depreciation on the income statement. As a result, the taxable income is reduced by $10K. Assuming a tax rate of 25%, expensing depreciation results in a tax savings of $2,500. Perhaps this is an oversimplified example, but the savings can be significant on a larger scale.

Calculating Depreciation

With the benefit of depreciation established, the question becomes, “how is the annual depreciation amount calculated?” To answer the question, three inputs are required:

➢ Cost Basis: The Cost Basis establishes the starting point for expensing depreciation. More often than not, it’s the purchase price of the asset.

➢ Useful Life: The Useful Life is an estimate of the property’s functional lifespan. Per IRS rules, there are some required standards, but a safe estimate is 27.5 years for residential property and 39 years for commercial. (3)

➢ Depreciation Method: Per IRS guidelines, there are multiple allowable methods to depreciate a property, but the most common is the “straight line” method, which divides the cost basis by the property’s useful life. (1)

Let’s put these inputs to work in an example. Assume a property with a $1MM purchase price, 39-year useful life, and straight-line depreciation method. In this scenario, the annual allowable depreciation would be $25,641 ($1MM/39). So, for every year an investor owns the property, they’ll be allowed to record this amount in depreciation expense, thereby reducing their taxable income. While this is great, there’s a hidden cost to be aware of.

Depreciation Recapture

If an investor has owned a property for a significant amount of time before selling it, there’s a hidden tax known as “Depreciation Recapture,” which is the tax that must be paid on the difference between the property’s sales price and cost basis.

Using the same example from above, let’s assume the same investor who purchased the property for $1MM is going to sell it after their 10-year holding period. If $1MM was starting point and $25,641 in depreciation was taken annually, then the property’s cost basis at the end of 10 years is $743,590 (($1,000,000) - ($25,641*10)).

Let’s also assume that at the end of the 10-year holding period, the property was sold for $1.2MM. Upon sale, the investor must pay taxes on the difference between the cost basis of the property ($743,590) and the sales price ($1,200,000). Assuming a 25% tax rate, taxes on the sale are going to be $114M. This can be a surprise for investors if it isn’t planned for and slightly offsets the benefits of expensing depreciation.

What to Do When Depreciation Runs Out

If a property has been held long enough for its cost basis to be reduced to $0, there may be a uniquely large tax bill associated with its disposition. In addition, the owner will no longer be able to reap the tax benefits of additional depreciation. So, they’ll likely consider doing one of three things:

➢ Nothing: An investor may choose to do nothing, which is fine, but their return on the property would likely be reduced since they’re no longer reaping the benefits of the depreciation expense.

➢ Sell The Property: The investor can dispose of the asset, but would face a hefty depreciation recapture tax in doing so.

➢ Exchange the property: Using a 1031 Exchange , an investor may sell the property and use the proceeds to buy a new property in a process known as a 1031 exchange. This option has two major benefits: (1) Taxes are deferred on the sale as long as the proceeds are invested into a property of “like kind;” and (2) The owner can start the depreciation process on the new property all over again.

Summary & Conclusions

Because it isn’t associated with direct returns on an investment, depreciation is an often overlooked benefit to real estate investing due to potential tax savings. To take advantage of it, it’s important to know the basics and to work with a qualified CPA to ensure that all required taxes are paid and that all allowable depreciation is taken. But, if a property is held for a long period of time, it’s important to account for the depreciation recapture tax, which can often catch investors by surprise and unprepared to pay it when the property is sold.

I specialize in helping my clients identify and select 1031 Exchange properties or DST properties that are suitable for their risk tolerance and time horizon. If you are interested in learning more about replacement options and/or DST investment opportunities , I’d like to invite you to set an appointment or to attend our next seminar. You can do so by calling me at 650-282-0477 or by sending an email at amit@Get1031Properties.com.

______________________________________________________________________________

(1) Accounting rules allow for depreciation on the structure and improvements only. Not land.

(2) Not to be taken as accounting advice. Always consult a qualified CPA who can provide advice relevant to your unique situation.

(3) Always consult a CPA

This is informational purposes only and does not constitute an offer to purchase or sell securitized real estate investments. Hypothetical examples are for illustration purposes only and individual results will very. There are risks associated with investing in real estate and Delaware Statutory Trust (DST) properties including, but not limited to, loss of entire investment principal, declining market values, tenant vacancies and illiquidity. 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. Because investors situations and objectives vary this information is not intended to indicate suitability for any particular investor. This material is not to be interpreted as tax or legal advice. Please speak with your own tax and legal advisors for advice/guidance regarding your particular situation.

Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Get 1031 Properties is independent of CIS.

Risks of Unusual Replacement Properties

joel@coaxconsulting.com (Joel Snyder) — Fri, 01 Nov 2019 16:29:22 GMT

A Section 1031 exchange can be completed by acquiring a wide variety of different replacement properties.
By Jorgen Rex Carlson

Although a good portion of 1031 exchanges are completed by acquiring a replacement property which mirrors the relinquished property, this isn’t always the case.

Currently, when it comes to real estate, Section 1031 tax law provides wide latitude when it comes to what sort of replacement properties qualify as “like-kind” to relinquished property. Taxpayers have exchanged all kinds of unusual properties. If you have a client preparing to conduct an exchange, they may be concerned about the eligibility of their prospective replacement property. Fortunately for taxpayers, the interpretation of the like-kind requirement is quite broad, and so taxpayers have a lot of leeway when it comes to selecting a potential replacement.

In this post, we will discuss the potential risks involved with selecting unusual replacement properties in an exchange. For now, as long as the prospective property is considered “real property” under local law, then it will qualify as like-kind to relinquished property.

The Like-Kind Requirement is Critical

As we’ve mentioned in an earlier article, the like-kind requirement is one of the four basic elements of Section 1031 law. The other three elements are actual transfer, eligibility, and the holding requirement. Simply put, your client needs to satisfy the like-kind requirement in order to have a successful exchange.

And there’s no way to bend or modify the requirement; either the replacement property qualifies as like-kind, or it doesn’t. Like the other three basic requirements of Section 1031, the like-kind requirement is rigid.

The good news is that the like-kind requirement is interpreted broadly. This means that your relinquished property and your replacement property don’t have to be superficially similar to qualify as like-kind.

If your client owns a residential rental property, they can choose raw land, a commercial building, an interest in a Delaware statutory trust , a 30 year leasehold interest in real estate, or another type of property and satisfy the like-kind requirement.

Replacement Property Must Be Real Property Under Local Law

The like-kind requirement is broad enough that it raises the question of where exactly the boundaries kick in. One useful guideline is that the like-kind requirement only refers to the nature of the property, rather than its quality or grade.

So, as long as the property itself is classified as real estate, then it should be eligible as replacement property. The IRS has issued documents to clarify a number of edge cases which seemed to push the boundary of the like-kind requirement.

For instance, the IRS has issued private letter rulings and revenue rulings in cases involving easements, which are temporary rights to real property. In PLR 9232030, for example, the IRS ruled that a perpetual agricultural conversation easement was like-kind to a fee interest in real property.

The IRS has issued documents in cases which involve water rights, oil rights and other interests in valuable materials. The general guideline is that a royalty interest is like-kind to real property.

As would be expected, clients will need to seek specialized counsel if they have a case involving one of these unusual properties. Thus far, however, Section 1031 tax law has upheld the principle that whatever is considered real property under local law (of the area housing the replacement property) will qualify as like-kind real property for purposes of Section 1031. This gives taxpayers wide latitude. If your clients want to expedite the process of determining the status of his or her target replacement property, he or she should check its status under the applicable state or local law.

Unusual Replacement Properties Carry Some Risks

As the existing body of Section 1031 case law and IRS statements show, not all rights or interests in property are eligible as replacement property. There have been numerous judicial opinions which denied like-kind qualification when an unusual property was selected.

If your client selects an unusual replacement property, there may be some degree of risk, especially if the unusual property hasn’t been scrutinized by the IRS or the courts. This is true even if that unusual property appears to be classified as real property under local law.

The reason for this is because there could always be a legal challenge by the IRS, and there is a possibility that the courts may narrow the interpretation of like-kind in a given situation. It’s always possible that a court may deny recognition of a given property as real property, even if local law holds otherwise, because the court things that the interpretation has become too broad in a given case.

Given what is at stake, be sure that your client seeks out a competent tax attorney in this area so that he or she can be properly counseled on the risks and probability of collapse. The IRS will challenge a case if it thinks that it has a good chance of success. Moreover, a replacement property which stretches the common sense interpretation of like-kind may be successfully impugned.

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Counseling Partnerships in a Section 1031 Exchange

joel@coaxconsulting.com (Joel Snyder) — Fri, 01 Nov 2019 16:18:44 GMT

Strategies known as "drop and swap" and “swap and drop”
By Jorgen Rex Olson

When accountants learn one of their clients is preparing to conduct a tax-deferred exchange under Section 1031 of the IRC, few are in a position to give any kind of useful counsel.

In these situations, usually, CPAs can point their clients in the direction of a qualified intermediary or tax attorney, but seldom can they identify potential issues or provide basic information on Section 1031 mechanics. This is particularly true with regard to partnerships.

These entities frequently perform 1031 exchanges , and the transactions tend to have their own unique issues and concerns. CPAs can improve their practice substantially by providing at least minimal levels of counsel on the various tax issues that can arise with partnership 1031 exchange transactions.

Obviously, CPAs should not be expected to advise their clients on every nuance of these issues, but they can at least offer some preliminary feedback and give guidance as to the most probable tax consequences that may follow in a given situation. Let’s go through each issue in turn.

1031 Exchanges: Drop & Swap or Swap & Drop

Whenever a regarded partnership conducts a 1031 exchange – that is, a partnership which files its own tax returns and is considered a separate entity from its members – that partnership will always face a critical question: Will the entity be performing the exchange, or will it be dissolved prior to the exchange and have its partnership interests be converted to interests in real estate?

For a 1031 transaction to be valid, the same entity that sells real estate must also be that which acquires it; in other words, there must be consistency of ownership across the entire period of the exchange. The seller must also satisfy all of the requirements of the 1031 as established by statutory and common law.

This is where the strategies known as "drop and swap" and “swap and drop” come into play. If a partnership consists of members who do not all wish to conduct the exchange, the traditional guidance is to dissolve the partnership and convert its interests into “tenants-in-common” (or “TIC”) ones so the relinquished property can be sold. The members who wish to proceed can do so and the exiting one (or ones) can go their own way.

Let’s look at an example: Suppose a partnership is comprised of three members, two of whom wish to conduct an exchange. The other, however, simply wants to cash out and exit the partnership. For simplicity’s sake, let’s suppose that the LLC owns real estate worth $300,000, and each member possesses exactly one-third.

In this hypothetical example, the partnership would need to “drop” the LLC into three distinct TIC interests that correspond to the ownership interests in the LLC. Then, when the real estate is eventually sold, the departing member would simply sell his/her TIC interest without an exchange contract, take the cash and pay taxes to the extent of the gain. The other two members would sell their TIC interests in an exchange and either buy separate replacement properties or work together to purchase a common one.

This is a very, very rudimentary example of a “drop and swap” exchange. In the swap and drop variation, this process is reversed. So, the partnership entity would conduct the exchange at the entity level. Then, the members would later drop the LLC into TIC interests so the exiting party could leave.

Between these two variations, the first (drop and swap) variation is the more common. This is because the other requires agreement between all partners participating in the exchange as to which replacement property they wish to acquire. It also necessitates cooperation from the exiting member, as they have to wait until all boxes are checked off in the exchange before they can cash out and leave.

In both of these variations, the key requirement that is potentially at issue is the holding requierment, one of the four main elements of Section 1031. It states that both the relinquished and replacement properties must be “held for” investment or business purposes by the owning entity.

If a partnership owns a property and drops into TIC interests prior to the sale, we can see how such a maneuver might trigger scrutiny of the holding requirement: Were the members possessing the TIC interests holding the property for investment or business purposes, or for sale? Remember, the entity that sells must be the entity that acquires. If the partnership is converted into TICs, then the members holding them must satisfy the 1031 requirements, not the original partnership.

Likewise, if the partnership is dissolved after the exchange in a swap and drop, then it must also satisfy the holding requirement with respect to the replacement property before converting to TIC interests. Again, it would be unreasonable for clients to expect their CPA to have expert guidance on more advanced scenarios, but those accounting professionals who can at least give introductory counsel will go far in distinguishing their practice from others.

If a given 1031 transactions doesn’t satisfy the holding requirement, the entire exchange can fail. This would mean your client will suddenly be slapped with capital gain taxes, penalties and interest to the IRS. If you can advise your customers on the mechanics, issues and potential consequences of these exchange strategies, you will be doing a lot to stand out from the crowd.

Exit Strategies: Partnership Installment Note Method

This is where CPAs can go a step even further and really help their clients.

If you come across a partnership client considering an exchange, you may want to discuss the so-called “partnership installment note” (“PIN”) method as one possible way of structuring the transaction.

These are basically variations on the swap and drop described above: Instead of staying in the exchange until after the replacement property is acquired, the exiting member (or members) receives a note for an amount consistent with their ownership stake in the LLC when the relinquished property is sold.

The exiting member receives this note directly from the buyer. It functions as compensation for leaving the entity and also allows the other remaining members to avoid recognizing any gain when payments on the note are made.

Let’s look at a hypothetical case of a PIN transaction.

A three-member LLC owns a property worth $300,000, and each member owns one-third. Instead of participating in the exchange, the exiting member leaves before the sale and receives a note that entitles them to one-third of the proceeds.

So, when the buyer obtains the property, he/she only transfers $200,000 to the entity. The other $100,000 is gradually transferred to the exiting member over time. If this amount were to be placed in the exchange, it may be subject to more taxation when it is received as “boot” by the entity and then paid out to the exiting member.

Hence, the PIN method avoids excessive taxation and also simplifies the process by keeping the LLC intact throughout the entire transaction on both ends.

Telling your clients about this and other strategies will help you stand out from the crowd and build a base of satisfied, loyal customers.

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Steps To Protecting Your Rental Property

joel@coaxconsulting.com (Joel Snyder) — Fri, 01 Nov 2019 02:48:54 GMT

Tenants are the source of revenue on rental properties, but they can also cause losses. A bad tenant could hurt your property in all sorts of ways.
By John Michelson

A rental property can be an incredibly valuable investment. While that’s a good thing, it also means that you have a lot of financial value and work tied up into one property. Your property — and your own financial security — could be at risk.

Ideally, most of the time things will be fine. The weather will be calm, your property will be treated well, nothing pernicious will happen on your property, and your tenants will be pleasant people who are neat and quick to let you know if you need to fix a leak or take care of a pest problem.

Unfortunately, sometimes you won’t be so lucky. What if a natural disaster strikes? What if your property starts losing money? What if your tenants don’t cooperate with you? Here’s how to protect your investment in your rental property.

Landlord insurance

Though not legally required, landlord insurance is all but mandatory for those who own rental properties. A rental property is something that is simply too valuable to leave unprotected.

Threats like natural disasters and break-ins could destroy your property and the value that you’ve invested in it. If you don’t have an insurance policy, the costs of making things right again will have to come out of your pocket — you may even have to give up and sell the property at a major loss. Make sure that you have landlord insurance and that your policy is comprehensive.

Preventative maintenance

Like any other architectural structure, a rental home or apartment building will wear down over time. That’s to be expected, but be careful: Neglecting maintenance and failing to make speedy fixes to things in need of repair will accelerate this process, causing your property to become less profitable and less valuable.

Here’s the smart move: Team up with contractors or a building management company and invest heavily in preventative maintenance. Preventative maintenance is usually cheaper than repair work, and nothing is more expensive than deferred maintenance.

Legal protections

Owning a rental property means, in effect, that you are running a business. You’ll have expenses, you’ll have revenue (in the form of rent), and — hopefully, anyway — you’ll have profits.

Businesses are tricky things, and they need to be set up properly from a legal perspective. This is important in part because your business could, in theory, lose a lot of money. Hopefully, it won’t, but if it does, then you will want your business to be a separate legal entity that insulates you from its losses. An LLC is a popular choice (though by no means the only one — make sure that you discuss all of your options with an attorney).

There are a lot of other reasons to set up your business on a solid legal footing, including liability issues and tax advantages. Do yourself a favor: pay a visit to an attorney. It will protect your property and your future financial wellbeing.

Tenant screening

A lot of things can threaten your rental property. Natural disasters could wreck the structure, maintenance problems could cause the space to deteriorate, and financial problems could cost you the whole enterprise. But there’s one threat that looms particularly large: bad tenants.

Tenants are the source of revenue on rental properties, but they can also cause losses. A bad tenant could hurt your property in all sorts of ways, from failing to report a leak until the damage is done to committing crimes on your property.

Kicking out bad tenants can be tough, especially in states and cities with powerful protections for renters built into their laws. That’s why it’s important to screen tenants with background checks and credit checks before you let them sign a lease agreement. Fortunately, a lot of great landlord software solutions offer free tenant screening among their other features.

5 Mistakes Real Estate Investors Should Avoid

joel@coaxconsulting.com (Joel Snyder) — Fri, 01 Nov 2019 02:23:53 GMT

Real estate investors and first-time home buyers face an uphill battle
By: Glen Carter

Real estate investors and first-time home buyers face an uphill battle in a slow real estate market. When it comes to buying and selling properties, it is still possible to make money, but it won't be easy. However, avoiding some classic mistakes will help put you on the right track.

Lack Of Research

Before most individuals buy a car or a television set they compare different models, ask a lot of questions and try to determine whether what they are about to purchase is indeed worth the money. The due diligence that goes into purchasing a home should be even more rigorous.

There are also research considerations for each type of real estate investor - whether a personal homeowner, a future landlord, a flipper or a land developer.

Not only must the prospective buyer ask a lot of questions about the home, but he or she should also inquire about the area (neighborhood) in which it is located. (After all, what good is a nice home if just around the corner is a college frat house known for its all-night keg parties? Unless of course, you're attracting a student renter.)

The following is a list of questions that would-be investors should ask regarding the home in question:

Is the property built in the vicinity of a commercial site, or will long-term construction be occurring in the near future?
Does the property reside in a flood zone or in a problematic area, such as ones known for radon or termite problems?
Does the house have foundation or permit "issues" that will need to be addressed?
What is new in the house and what must be replaced?
Why is the homeowner selling?
What did he or she pay for the home and when?
If you are moving into a new town, are there any problem areas in town?

Getting Lousy Financing

Though the real estate bubble in North America ostensibly popped in 2007, there are still a large number of exotic mortgage options. The purpose of these mortgages is to allow buyers to get into certain homes that they might not otherwise have been able to afford using a more conventional, 25-year mortgage agreement.

Unfortunately, many buyers who secure adjustable/variable loans or interest-only loans eventually pay the price when interest rates rise. The point is that home buyers should make sure that they have the financial flexibility to make the payments (if rates go up). Or they should have a back-up plan to convert to a more conventional fixed-rate mortgage down the line.

Doing Everything on Your Own

Many buyers think that they know it all, or that they can close a real estate transaction on their own. While they might have completed a number of deals in the past that went well, the process may not go as smoothly in a down market - and there is no one you can turn to if you want to fix an unfavorable real estate deal.

Real estate investors should tap every possible resource and befriend experts that can help them make the right purchase. A list of the potential experts should, at a minimum include a savvy real estate agent, a competent home inspector, a handyman, a good attorney and an insurance representative. These experts should be capable enough to alert the investor to any flaws in the home or neighborhood. Or, in the case of an attorney, he or she may be able to alert the home buyer to any defects in the title or easements that could come back to haunt them down the line.

Overpaying

This issue is somewhat tied into the point about doing research. Searching for the right home can be a time-consuming and frustrating process. And when a prospective buyer finally finds a house that actually meets his or her needs/wants, the buyer is naturally anxious to have the seller accept the bid.

The problem with being anxious is that anxious buyers tend to overbid on properties. Overbidding on a house can have a waterfall effect of problems. Buyers may end up overextending themselves and taking on too much debt, creating higher payments than they can afford.; as a result, it may take years for the home buyer to recoup this investment.

To find out whether your dream investment has a high price tag, start by searching what other similar homes in the area have sold for in recent months. Any real estate broker should be able to provide this information with relative ease (particularly with their access to a multiple listing real estate agent database). But as a fallback, or if you are not using a realtor's services, simply look at comparable homes in the local newspaper, and see what they are being offered for. Logic should dictate that unless the home has unique characteristics that are likely to enhance its value over time, the buyer should try to keep any bids consistent with other home sales in the neighborhood.

Buyers should realize that there are always other opportunities out there, and that even if the negotiation process becomes bogged down or fails, the odds are in their favor that there is another home out there that will meet their needs. It's just a matter of being patient in the searching process.

Underestimating Expenses

Every homeowner can attest to the fact that there is way more to owning a house than just making the mortgage payment. Unlike renting, there are maintenance expenses that go along with mowing the lawn, painting the shed and tending the garden. Then there are the costs associated with furnishing the house and keeping all of the appliances (such as the oven, washer/dryer, refrigerator and the furnace) running, not to mention the cost of installing a new roof, making structural changes to the house, or other little things like insurance and property taxes.

The point is that first-time investors tend to forget these costs when house hunting. Unfortunately, this is exactly why many new homeowners tend to be house poor and cash poor.

The best advice is to make a list of all of the monthly costs that are associated with running and maintaining a home (based upon estimates) before actually making a bid on one. Once those numbers are added up, you'll have a better idea of whether you can really afford a property.

Determining expenses prior to purchasing a property is even more important for house flippers and investors. That's because their profits are directly tied to the amount of time it takes them to purchase the home, improve it and resell it. In any case, investors should definitely form such a list. They should also pay particular attention to short-term financing costs, prepayment penalties and any cancellation fees (for insurance or utilities) that might be borne when the home is flipped in short order.

Bottom Line

The reality is that if investing in real estate were easy, everybody would be doing it. Fortunately, many of the struggles that investors endure can be avoided with due diligence and proper planning before the contract is signed.

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How Does A 1031 Exchange Affect the Seller?

joel@coaxconsulting.com (Joel Snyder) — Fri, 01 Nov 2019 02:06:26 GMT

Learn how entering into a sale with a 1031 exchange buyer impacts you as the seller.
By: Amanda Sapio

When listing a property for sale, there are few greater reliefs than finding a buyer who's prepared to purchase your property. When learning that the buyer plans to execute a 1031 exchange, several questions may immediately come to mind.

The most common concerns typically include, "How will this affect me as the seller?" and "Why is my buyer going this route?"

To create some context, let’s start with what a 1031 exchange is and why your buyer may be choosing this option.

Why is the buyer choosing to do a 1031 exchange in the first place?

When a property sells, sellers must pay capital gains tax on the amount that the property has appreciated. If you purchased a property for $600,000 and sold it for $900,000, you'd pay capital gains tax on that $300,000 increase.

However, when an investor enters into a 1031 exchange, they can defer (postpone) that capital gains tax. The federal government lets investors defer capital gains tax if they put the proceeds from the sale directly into another property.

According to the IRS, that second property must be "like-kind." That means it must be used for productive use in a trade, business, or investment and cannot be a personal residence that the investor inhabits.

An investor only has 45 days to identify that your property is the one they wish to purchase, so their time is extremely limited. From there, they then have 180 days to close on your property. So things will move quickly!

How will the 1031 exchange affect me as the seller?

For starters, you should include language in your contract specifying that there won't be an additional cost to you to work with a buyer in a 1031 exchange.

It's also important to note that when your buyer sells their original property, they're not allowed to hold the funds (referred to as "proceeds") that they'll use to purchase your home.

Even though it's technically the buyer's money, they must hire a third-party agent -- known as a qualified intermediary -- to hold the funds. When the time comes for the buyer to purchase your property, the qualified intermediary will send the funds to you and close the sale.

As a seller, you should have language included in your contract acknowledging that

you're aware of the buyer's intent to complete a 1031 exchange,

you agree to cooperate at no additional cost or liability to you, and

you're aware that the buyer has certain rights assigned to a third party (the qualified intermediary).

As the seller, can I enter into a 1031 exchange?

When working with a buyer in a 1031 exchange, you may find yourself wondering if you have the option to enter into a 1031 exchange as well.

If you want to execute a 1031 exchange, the property you plan to buy must be used for productive use in a trade, business, or investment -- it cannot be a personal residence. You'll also need to hire a qualified intermediary to hold the funds for your exchange.

As mentioned above, executing a 1031 exchange must happen within a very strict timeline. You have to identify the property you plan to buy within 45 days and close on that property in 180 days.

Not only will you defer capital gains tax, but you may also be able to defer all or some of any depreciation recapture tax liability. There's no limit to the number of 1031 exchanges you can perform. Under current federal estate tax law, you could defer gains indefinitely until the property passes to your heirs, who then receive a stepped-up cost basis. That negates a liability on years of capital gains.

Key Takeaways...

The 1031 exchange is a popular and valuable tool used by many real estate investors. If you're a seller and your buyer is making an exchange, speak with your real estate agent about including specific language in your contract that states you're participating in the 1031 exchange.

Understanding the details involved in a 1031 exchange will not only be beneficial to you during the sales process but will also help you decide whether or not you want to execute an exchange as well.

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How a DST May Be a Solution for Aging Rental Property Owners

Sun, 30 Jun 2019 00:52:37 GMT

For investors nearing retirement age and looking to generate more income.

With the exception of 4 recessionary periods, the United States economy has experienced significant growth since July of 1980. If you’ve been a real estate investor for any length of time during this expansion, odds are that you’ve experienced material price appreciation in your holdings. If you started investing towards the beginning of the expansion, you may also be at an age where: (1) you’re tired of actively managing your properties; and (2) you’d like to enjoy the fruits of your success.

For individuals who find themselves in this situation, there are two traditional options to consider:

1. Sell the property and pay the taxes:
This is the easiest and most straightforward solution. Selling the property allows the owner to realize their gains, but it also comes with an unpleasant downside, a big tax bill. In 2019, the top federal capital gains tax rate is 20% depending on income and filing status (it may be higher in certain states such as NY and CA)[ 1]. Because this is significant, many investors are driven to consider ways to defer taxes on their gain, which creates a second option;

2. Sell the property and reinvest the proceeds via a 1031 exchange:
With this option, the property is sold in the same way as option #1, but the proceeds are reinvested into another property using something called a 1031 exchange. Under section 1031 of the Internal Revenue Code, gains on a property may be deferred, allowing the owner to redeploy the capital that would have been paid in taxes, as long as they are reinvested into a property of “like kind” within 180 days of the sale date[2].

A 1031 exchange is a great solution for the tax issue, but it doesn’t take care of the active management problem, which can be time consuming and stressful. For investors nearing retirement age and looking to generate more income, this is likely something that they just don’t want to deal with.

Luckily, there is an alternative option that solves both the tax issue and the active management issue while potentially generating more income and providing individual investors with access to institutional quality assets that they wouldn’t otherwise be able to invest in. It is called a Delaware Statutory Trust (DST) and the purpose of this article is to provide an overview of the DST option and to explain how it may benefit a specific type of investor.

What is a Delaware Statutory Trust?
A Delaware Statutory Trust is “a legally recognized entity that is set up for the purpose of conducting business. They are formed using a private trust agreement under which real property is held, managed, invested, administered, and/or operated for the purpose of profit.”[3]

In August of 2004, the Internal Revenue Service ruled that “a taxpayer may exchange real property for an interest in a Delaware Statutory Trust without recognition of a gain or loss under section 1031, of the other requirements of 1031 are satisfied.”[4] For an aging investor with significant gains and SEC accreditation (net worth of $1MM or annual salary of $200K or more for the past 2 years)[5], this ruling created an attractive replacement option:

3. Sell the property and reinvest the proceeds into a Delaware Statutory Trust (DST):
Similar to option #2, the investor sells their property, but instead of reinvesting the proceeds into traditional real estate, the proceeds are invested into Delaware Statutory Trust. This investment solves both issues; because of the aforementioned IRS ruling, gains are deferred under section 1031 and because a DST is professionally managed, the investor doesn’t have to worry about a late night phone call or an unexpected repair bill.

What are the advantages of investing in a Delaware Statutory Trust?

In short, a DST provides all of the benefits of owning real property, but without the hassle of managing it.

DSTs are managed by best in class real estate firms such as Inland Private Capital Corporation, Passco, or BlueRock who use their decades of expertise to select institutional quality assets and make them available for investment through the DST structure. They take on the burden of identifying, analyzing, and purchasing high quality real estate assets and eliminate the headache of actively managing them.

In addition to offering high quality assets without the management headache, DSTs offer a host of other benefits:

They are available in all asset classes, including retail and multifamily, which are popular with investors looking for passive income;
They have low minimum investments, allowing investors to diversify by mixing and matching their sales proceeds;
They can be used as an estate planning tool since the investment is easily divisible by heirs and allows them to inherit it at a stepped up cost basis;
May potentially offer investors significantly more income compared to what they are currently making. DSTs usually activate the idle equity trapped in many Bay Area properties, with returns ranging from 5-7%.
Lastly, with a new deprecation schedule, many investors are able to shelter more income from taxes, allowing DST owners to keep more money in their pockets when compared to their current rental property.

Are there any drawbacks?

Despite the numerous DST benefits, they may not be a proper fit for all investors. There are a few drawbacks to consider:

DST investments are illiquid and usually require a holding period of 5-10 years.
DST investors have no control over property management decisions. If there is a management strategy disagreement between the investor and manager, the manager always wins.
Per IRS requirements, a DST may not raise new capital once the fund is closed. As such, a big ticket repair such as a roof or HVAC system has the potential to erode years of profits. Because of this, adequate reserves are essential to the successful operation of the DST.
Interest rates and/or the overall real estate market may impact the overall return
Fees and expenses charged by the manager may potentially offset the investment return

What Should I do if I’m interested?

I specialize in helping my clients identify and select DSTs that are suitable for their risk tolerance and time horizon. If you are interested in learning more about DST investment opportunities , I’d like to invite you to set an appointment or to attend our next seminar. You can do so by calling me at 650-282-0477 or by sending an email at aurban@firstguardiangroup.com .

Footnotes:

1 - IRS Topic 409 - Capital Gains and Losses

2 - Section 1031

3 - Delaware Statutory Trusts - Wikipedia

4 - IRS Revenue Ruling 2004 - 86

5 - SEC Accreditation defined under Rule 501 of Regulation D

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How expensing depreciation reduces the taxable income of the property
By Amit J. Urban

A Section 1031 exchange can be completed by acquiring a wide variety of different replacement properties.
By Jorgen Rex Carlson

Strategies known as "drop and swap" and “swap and drop”
By Jorgen Rex Olson

Tenants are the source of revenue on rental properties, but they can also cause losses. A bad tenant could hurt your property in all sorts of ways.
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Real estate investors and first-time home buyers face an uphill battle
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Learn how entering into a sale with a 1031 exchange buyer impacts you as the seller.
By: Amanda Sapio