Investors who start their 1031 exchange transactions on a high note can often find themselves plummeting when faced with unexpected challenges.
A Cautionary Case Study
Michael Englesworth had $2M in real estate equity to exchange. He identified a good property and was ready to nominate it. Excited to move forward, he believed the process would move ahead smoothly and he’d nominate it within the 45-day timeline.
That’s when the problems started popping up. The seller described the net operating income as $500,000 per year, and the building’s new roof and plumbing. As Englesworth started investigating, however, he found out that this wasn’t an accurate picture. He decided he couldn’t buy it, but his 45 days have come and gone and he was stuck stuck. Englesworth could either buy the property, even though he was no longer sure it was a wise decision, or not, and pay a hefty tax bill.
Why DSTs Are Perfect For Backup Property Identification
Even if you have a property in mind to nominate, there is still good reason to nominate a Delaware Statutory Trust (DST) as a backup property. When you do that, you ensure that if you don’t buy the first property, you’ll still have an avenue to avoiding large capital gains taxes, plus healthcare and state taxes.
A 1031 exchange allows you to nominate up to three properties, any or all of them can be Delaware Statutory Trusts. They’re a completely safe and wise nominating choice because the property has already been purchased, all due diligence has been done, the loan is in place, and all negotiations have already been completed.
What Is a DST?
A DST is a business entity, through Delaware state law, that allows investors to take a fractional ownership of properties that produce consistent and predictable cash-flows.
A real estate sponsor firm acquires properties under the DST umbrella. Then the firm opens up the trust to potential investors, who can deposit their 1031 exchange proceeds, or purchase an interest in the trust directly.
Investor Protection and Flexibility
The simple filing requirements of a DST protect investors. Because the DST certificate shows only the name of the trust and the name and address of the Delaware trustee, the identities of the beneficial owners of the trust can remain private and protected. After a one-time fee due upon filing the certificate of trust, there are no annual fees or additional filing requirements.
DSTs allow the parties involved to decide the details of the business relationship, thus giving investors the freedom and flexibility to determine what best meets their needs. Investors are protected from liability because DST members and managers have no personal liability for the debts and obligations of the trust.
DSTs can be structured to be a tax efficient alternative to corporations, as they do not have to be subject to tax at the organizational level.
DSTs also give small equity investors an excellent opportunity to enter into, and benefit from, large commercial real estate transactions that they could not enter into on their own.
DSTs can be used for a wide range of investments and business transactions, and are a perfect safety net for your 1031 exchange. To take advantage, you’ll need to find an investor-director provider of DST property investments.