A 1031 exchange has some challenges built in, and a key obstacle to exchange success can be identifying suitable replacement properties within 45 days and securing financing and closing on the purchase within 180 days.
In a Delaware State Trust, investors are not direct owners of the real estate; they hold beneficial interests in the trust. This takes away the need for the investor to be on the deed and sign the loan documents. The number of investors in a DST (assuming compliance with securities laws), is not an issue to lenders, and the limitation to 35 investors set forth in Revenue Procedure 2002-22 also does not apply.
A DST’s property sponsors are DST real estate developers who purchase the property and structure it according to the trust specifications. There is a written offering document that provides detailed information on tenants/leases, area demographics, financial projections, investment risks, and information about the property sponsor. Supporting documentation includes third-party appraisal, property condition, and environmental reports. Mortgage bank financing and property management are pre-arranged by the property sponsor. In a non-DST exchange, the exchanger would have to spend considerable time and effort to resolve. Reserves are set up to fund future capital expenditures, tenant improvement and leasing commissions for new tenants, and contingency funds for unexpected events. Any reserves remaining upon property sale are returned to the investors. Oftentimes, individual real estate owners do not adequately reserve for such future expenses and contingencies. Investors receive net monthly distributions after paying operating expenses, mortgage payments, and reserve contributions. The annualized income is generally 6%-7% of their cash investment amount.
With a properly selected DST with pre-existing debt in place, investors will not need to qualify for, apply for, or take out their own mortgage, yet they can still qualify for Section 1031 exchange using only their net proceeds from the sale of their real estate. There is no need to set up LLCs for individual members of the trust, and the DST property shield individual investors from personal liability.