Leveraging Delaware Statutory Trusts in 1031 Exchanges: A Guide to Deferring Capital Gains Tax

Section 1031 and Its Tax Benefits

Section 1031 of the Internal Revenue Code offers a robust method to delay capital gains tax that might accrue from selling a business or investment real estate. By trading real property for similar real estate, owners can defer taxes, allowing them to reinvest the proceeds in new property. Note: This doesn’t include the owner’s main residence.

However, executing a 1031 exchange demands adherence to specific guidelines. For example:

• The money used for the new property should match or surpass the amount from the sold property.
• The combination of the invested cash and debt on the new property must equal or exceed the cash and debt from the old property. Put simply, while you can use extra cash to compensate for less debt on the new property, additional debt can’t replace a lack of invested cash. Those considering this route should consult with tax experts.

DSTs are a Prime Solution for Shared Ownership

Delaware Statutory Trusts (DSTs) enable shared ownership, letting multiple investors own a single property or a collection of properties. These can serve as replacement properties in a 1031 exchange. In a DST, the investors are not in charge of decision-making; instead, a knowledgeable trustee affiliated with the sponsor handles it.

The Process of 1031 Exchange with DSTs

1. SALE: The investor sells a property (the “relinquished property”). The resulting funds are held by a Qualified Intermediary (QI).
2. PURCHASE: The QI, having an agreement with the investor, uses these funds to buy replacement property.
3. EXCHANGE: The investor then gets a beneficial interest in a DST.

Why Consider DST 1031 Exchanges?

• Estate Planning: With a 1031 exchange, investments benefit from a stepped-up cost basis, ensuring heirs don’t inherit capital gain debts. Plus, they get the advantage of expert property management.
• Insurance Clause: If an investor faces challenges in acquiring their primary identified property, DSTs offer an alternative to fulfill exchange timelines, preserving the tax deferral.
• Avoiding Tax on Excess Profits: Any leftover profit from the sold property is “boot”, which is taxable unless dealt with. This surplus can be invested in DSTs to sidestep the tax.
• Swap Until You Drop: DSTs let investors repeatedly exchange properties until they pass away.
• No Management Hassles: DSTs take the reins of property management.
• Access to Prime Properties: DSTs pave the way for partial ownership in high-value properties, making them accessible for many.
• Limited Personal Risk: Loans don’t fall back on the investor; DSTs bear the responsibility.
• Flexible Investment Minimums: DSTs often have more accommodating investment thresholds compared to the typical $100,000 for 1031 exchanges.
• Diversification: By investing in various DSTs, one can spread their investments across different regions and property types.