Doing a 1031 Exchange is an excellent way to sell your property and defer the tax liability. But timing rules have caused some people to fail when doing the exchange. My guest today has the answer to those facing problems doing a 1031 Exchange. Peter Fisher of Sequent Real Estate and Wealth Management is here to talk about the different tax deferral strategies available to real estate investors and how a DST can be a solution to a failed 1031 Exchange.
The company was founded a year ago to act as a financial adviser to their clients. As a client-focused organization, they provide solution-based advice aligned to the long-term objectives of their clients.
Their clients include baby boomers who are retiring. Typically, this generation of individuals are looking to sell their investment properties and want to defer paying their taxes. While they’re still interested in owning real estate, they don’t want to deal with property management.
The 1031 Exchange was introduced in 1921 and since then, it’s been used in real estate and personal property. It allows individuals to sell investment real estate and defer the tax liability by exchanging the proceeds into another replacement real estate.
There are rules involved in doing a 1031 Exchange. One has to do with timing. Individuals have 45 days from the sale of their property to identify the replacement property they will purchase. Also, they have 180 days from the sale to close on that replacement property.
Another rule dictates that individuals can’t take constructive receipt of their proceeds. So, they’ll have to set up a third-party escrow that’ll cost between $1,000-1,500.
This is a legal entity that owns and manages a property on which investors can purchase fractional interests from. DSTs allow multiple individuals to share ownership of single or multiple properties. Around 75% of DST offerings are multifamily properties. These are generally large institutional assets worth $50-100 Million and are 200-500 unit properties. Often located in Class A secondary growth markets, it offers individuals the ability to invest in large, professionally managed, passive income-producing properties.
The DST offers many benefits that help investors trying to do a 1031 Exchange. It gives investors the ability to diversify their portfolio and risk by being able to invest across multiple states and asset classes. A DST is also a possible investment choice for those doing 1031 Exchanges.
One example is a Bay Area property purchased 30 years ago for $100,000. At the time when the owners were selling the property, it was worth $2 Million. Because the property used to be a primary residence and for the last 2 years was used for trade and business, they were able to do both a 1031 Exchange and a Section 121.
Section 121 offers a tax-free exclusion of up to $500,000 in the sale of single-family homes used as a primary residence. The owner then used the $1.5 Million proceeds left in taxable gain and exchanged it for fractionalized real estate through the DST.
It starts with a real estate sponsor which would be an engrained, large real estate group. The group does the due diligence and acquires a property. They’ll secure the financing and put out the down payment.
With loan-to-value for these deals generally at 50%, an $80 Million Class A multifamily property in Phoenix, Arizona could mean the group has to shell out $40 Million of their own capital. This is different from a syndication that first pools money from multiple investors before securing the property.
After a property is acquired, the group then offers fractional interests on the property to investors. A typical DST will be available for 30-45 days. But a $100-200 Million portfolio can be available for 2-3 months. Investors can come in when they like.
A 1031 Exchange requires the replacement property to be of equal or greater value than the relinquished property. So in cases where if the replacement property was a lower value, a DST can be used as a boot solution for the leftover.
DSTs could also be used as a backup if you’re on your 45th day and haven’t found a replacement property yet.
Every election cycle, something is always brought up regarding 1031 Exchanges. The Biden Administration through the American Families Plan is looking to abolish deferring gains over $500,000. This means only the first $500,000 can be deferred. Any amount after that would be subjected to taxes.
There’s also the possible removal of the stepped-up basis. This can drastically impact the estate plans of families as the stepped-up basis reduces the taxable capital gains tax from when a property is inherited. A lot of families hold on to real estate for that purpose.
Everything is unknown. We can only plan for what we know. So there’s no need to sell your property in a panicked state. Think about your long-term goals before making a decision because there are real estate exchange solutions and other strategies available.
When you’re executing a 1031 Exchange, always consider all the different options out there. Learn more about the DST because it can save a failed exchange. It can lessen the pressure from the time limit, and it can also be very useful.
Opinions expressed on this program do not necessarily reflect those of Sequent Real Estate and Wealth Management, CIS, CAM and CIA. The topics discussed, and opinions given are not intended to address the specific needs of any listener. Sequent Real Estate and Wealth Management does not offer legal or tax advice, listeners are encouraged to discuss their financial needs with the appropriate professional regarding your individual circumstance. 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. Past performance is not a guarantee of future results. Potential cash flow, returns and appreciation are not guaranteed. IRC Section 1031 is a complex tax concept; consult your legal or tax professional regarding the specifics of your particular situation. This is not a solicitation or an offer to sell any securities. 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. Sequent Real Estate and Wealth Management (SREWM) offers securities through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Advisory services offered through Concorde Asset Management, LLC (CAM), an SEC-registered investment advisor. Insurance offered through Concorde Insurance Agency, Inc. (CIA) SREWM is independent of CIS, CAM and CIA.
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