The Problem with Today’s Hot Real Estate Investment Market

Jessica Schmidt (not her real name) is a qualified agent for a large national firm specializing in 1031 investment property exchanges. Lately she has been working 10 hours a day, six days a week.

On some days, she takes up to 50 calls a day from real estate investors who want to make money in a hot real estate market without paying big bucks in taxes on their prized real estate investment.

It’s a seller’s market, and most real estate investors can achieve a quick sale for amounts previously only dreamed of.

Everything great, right? Not so fast.

A vendor’s market isn’t exactly a dream

Jessica typically spends 10-15 minutes with a caller explaining the rules and regulations of a 1031 operator. She often directs callers to her website for instructional videos on the 45-Day Rule, 3-Ownership Rule, and 180-Day Rule. These are all essential and specific requirements for an investor to take advantage of our Tax Code’s ability to defer taxes on a real estate sale.

She explains that the seller must open an exchange “ticket” PRIOR to completing the sale of their investment property. The seller then has up to 45 days to identify a qualifying replacement item.

And that’s where the situation gets tricky.

Problems finding replacement objects

“The problem with the inventory in the market is that there isn’t any,” the chief economist of a major national title company was quoted as saying at a recent business forum.

These days, hopeful 1031 stock market investors often find themselves in quite a conundrum. According to Jessica, the expensive sale and tax deferral through the 1031 exchange may be the easy part, but finding a suitable replacement property seems to be the biggest hurdle and a common dilemma.

One possible solution – DST or Delaware Statutory Trust

With that in mind, Jessica is increasingly offering her clients another option to consider instead of a 1031 exchange: a DST, or Delaware Statutory Trust.

DSTs are passive real estate investments that qualify as replacement real estate for 1031 exchanges. DSTs invest in apartment buildings, medical buildings, self-storage facilities, Amazon distribution centers, industrial warehouses, hotels and other major real estate asset classes. The investments are passive in nature and generate regular monthly income for investors as well as the potential and opportunity for growth.

Many DSTs are syndicated with some debt, typically around 50% loan-to-value. However, the liabilities to investors are considered non-recourse, meaning that an investor has no personal guarantee or personal liability for these liabilities. This could be very helpful, Jessica explains to her clients, because they all want a full tax deferral, and the rules state that if an exchange is made, the investor must reinvest the proceeds of the sale AND pay any debt.

DSTs have been around since 2004 when the IRS issued ruling 2004-86 qualifying DSTs for exchange in a 1031 exchange.

Must be an accredited investor

DSTs are for “accredited” investors only, meaning an investor must have at least $1 million in net worth or $200,000 in income for a single person or $300,000 for a married couple in addition to their primary residence . And DSTs are offered as SEC-registered securities and are therefore available from broker-dealers or registered investment advisers. Advisors perform comprehensive due diligence on property syndications and each individual DST-sponsored property.

Jessica concludes that DSTs could be a perfect fit for many of her clients and investors, particularly those approaching retirement who may no longer wish to manage active real estate assets. Given the tax savings, the passive nature of the investments, and the high quality assets that are generally part of the DST, many of their clients’ problems could be effectively solved with this important passive investment strategy.

Although DSTs attract billions of dollars in mutual funds, most CPAs and real estate investors are still unaware of this important and viable solution that could potentially solve so many problems for so many real estate investors.

After explaining all of this to clients so many times over the past few months, Jessica decided to come up with the following top 5 “Letterman” style benefits of DST for her clients:

5 Top Benefits of DSTs in a 1031 Exchange

1. Potentially better total returns and cash flows

It depends on the investor. Still, some investors think DSTs may offer a better risk/reward profile than a property they might manage themselves.

2. Tax planning and obtained step-up basis

DSTs provide the same real estate tax benefits that an investor would own and manage themselves. Depreciation and amortization are passed on proportionately to the DST investors. In the future, DSTs can again be exchanged for another DST via a 1031 exchange.

3. Freedom

Passive investing gives older homeowners the time and freedom to travel, pursue other ventures, spend more time with family and/or relocate away from their current real estate wealth.

4. As a backup strategy

In a competitive market, an investor may not be able to find a suitable replacement property for their 1031 exchange. DSTs could be a good backup option and could be named/identified in an exchange if only for that reason.

5. Capture equity in a hot market

When markets reach all-time highs, investors may want to take their profits off the table and reinvest them using leverage within a DST offering.

DST investment carries a level of risk inherent in real estate investing and is offered only to accredited investors and only through a private placement memorandum. Therefore, a prudent investor would be best served to evaluate all the details of each specific offering and the track record of the sponsoring company before investing in a DST offering.

This article was written by and represents our contributing consultant, not the Kiplinger editorial board. You can view advisor filings with the SEC or with FINRA.

Chief Investment Strategist, Provident Wealth Advisors

Daniel Goodwin is Chief Investment Strategist and Founder of Provident Wealth Advisors, Goodwin Financial Group and Provident1031.com, a division of Provident Wealth. Daniel holds a Series 65 securities license and a Texas Insurance license. Daniel is an investment advisor representative and a trustee for the companies’ clients. Daniel has been serving families and small business owners in his community for over 25 years.