123rf.com: Willy Deganello
Viable solutions to the 1031 exchange time crunch
The real estate market entered 2015 on solid footing with many markets at or above pre-recession levels. Along with these prices come many owners interested in selling their properties and searching for a viable replacement property as they plan to utilize the section 1031 exchange to defer their capital gains taxes.
Many investors are tired of the tenants, toilets and trash that come with owning and managing apartments and commercial properties and they are looking for a 1031 exchange property without the headaches of property management.
One option that 1031 exchange investors need to be aware of is utilizing a Delaware Statutory Trust (DST) 1031 replacement property.
“Many of our clients had previously never heard of DST properties and how they can be used as 1031 exchange replacement properties,” says Dwight Kay, founder and CEO of Kay Properties and Investments.
“But there are definite strategies investors should look at that can potentially provide tax advantages and allow them to utilize a 1031 exchange while avoiding some of the headaches that go along with owning apartments and other commercial properties.”
Despite the name, the property doesn’t have to be in Delaware. Kay, for example, says his California and New York-based company works with clients and properties in all 50 states. “Whether it be, for example, a Costco in Utah, a Walgreens in New Jersey, a CVS in Florida, or a 300 unit multifamily apartment property in Texas, our clients are able to invest from as little as $100,000 to over $5,000,000 via a 1031 exchange into our Delaware Statutory Trust (DST) properties.”
A 1031 exchange allows someone to defer their capital-gains taxes on a property sale if they reinvest the proceeds in “like-kind” property. Such properties can include apartment buildings, vacant land, farmland, office buildings and warehouses among other properties.
A Delaware Statutory Trust is a trust that lets investors buy an interest in commercial property, but managing the property is left to others. Because Delaware Statutory Trust properties are pre-packaged for 1031 exchange investors, they provide a very viable solution for 1031 exchange investors that only have 45 days to identify what they are going to exchange into.
Kay says Delaware Statutory Trust properties have several potential characteristics that 1031 investors should be aware of and consider:
- Diversification – Kay says many of the investors he deals with are at a stage in life where they want to diversify their real estate holdings. “Although diversification does not guarantee profit or guarantee against loss, they realize having a large portion of their net worth in a single property is potentially not prudent,” he says. “Why would you bet the farm on a single piece of property?” A Delaware Statutory Trust allows a diversified approach that potentially makes more sense, whereby investors are creating for themselves multiple potential income streams from multiple tenants, multiple geographic locations, multiple asset classes (or types of real estate), etc.,” he says. The relatively low minimum investment of $100,000 allows investors to build for themselves a diversified 1031 exchange solution.
- Inflation protection potential – Many 1031 investors gravitate towards triple-net-leased properties, as the tenant is typically responsible for all maintenance, taxes and insurance at the property. However, “the problem with most triple-net-leased properties is the potentially flat to minuscule rental increases that could cause values to suffer,” Kay says. DST properties allow 1031 investors access to types of properties that have shorter-term leases that will potentially track better with inflation, such as multi-family apartments and grocery anchored retail centers, without the burden of active management.
- Quick closings – DST properties are prepackaged for 1031 investors to be able to close on immediately. “For an investor in a time crunch, a DST is a good solution to a very real danger of a failed 1031 exchange due to not being able to find a property they know they can close on,” Kay says. “Often, 1031 investors face a very real risk of not being able to close in time because of a number of issues, such as financing not coming through or issues with appraisals or environmental reports. A lot of things can go wrong with trying to purchase a typical apartment or triple net property. The DST 1031 provides a potential solution to those investors who don’t want to be burdened with those closing risks,” Kay says.