1031 Exchanges/DSTs

The term 1031 Exchange is defined under section 1031 of the IRS Code. Broadly stated, this strategy allows an investor to defer paying capital gains taxes on an investment property when it is sold, as long as another “like-kind property” is purchased with the profit gained by the sale of the first property. A Delaware Statutory Trust (or DST) is a separate legal entity created as a trust under Delaware Statutory Law. A DST allows you to co-invest with other investors in one or numerous properties. Although DSTs aren’t new, current tax laws have made them popular among 1031 exchange investors.

Purchasing into a Delaware Statutory Trust is treated as a direct interest in real estate. Investors are assigned fractional ownership of equity and debt, fulfilling their exchange requirements. Minimum investments are typically between $25,000 and $100,000: Therefore, a single investor may own a fractional interest in an entire property or portfolio and receive proportional distributions from the operation of the trust, from rental income, and from the eventual sale of the assets.

In 2018, the DST market was $2.4B, and this is expected to grow to $3B+ in 2019.* There are multiple reasons why real estate investors are embracing DSTs.

  1. There are no management responsibilities for the investor. For real estate investors, property management may be time-consuming and stressful. Some investors find that it can be a major relief to hand over the management and the decision-making responsibilities to a professional team of experienced managers.
  2. Individual investors can access larger, investment-grade properties. Most real estate investors cannot afford to invest in multi-million-dollar properties on their own. DSTs provide a unique opportunity for investors to acquire partial ownership and experience the benefits of these types of properties.
  3. There are opportunities for diversification. Because the investor can choose the investment amount in a DST, the investment can be split amongst multiple DST properties. This allows for diversification of real estate sector and geography, which potentially minimizes concentration risk. Alternatively, the investor could also pool the sale of multiple assets into the purchase of one asset.
  4. DSTs generally pay regular distributions. DSTs are permitted to keep a reasonable amount of cash reserves to be prepared in the event the property requires repairs or faces unexpected expenses. However, all earnings and proceeds above the reserve amounts must be distributed to the beneficiaries on a regular basis and within the expected timeframe.
  5. Investors do not have to qualify for the property’s mortgage loan. The loan is usually “non-recourse”, meaning the only liable entity is the Delaware Statutory Trust itself, not an investor’s individual assets. This also means that an investor’s personal assets and liabilities outside from the Trust cannot affect the status of the loan, and the investor does not need to provide personal documentation for loan approval.
  6. One of the largest concerns of investors is meeting the timelines set by the IRS. Upon the sale of a property, an investor has 45 days to find a new property and 180 days to close on that property. When either of these deadlines is missed, the investor has to pay taxes on capital gains from the sale. An investment in a DST can close very quickly, so investors have less worry about the timeliness of acquisition transactions or market competition.
  7. Because of the strict transaction timelines, a DST can serve as a 1031 exchange backup plan.  During one’s identification period, a 1031 exchange investor may identify a DST property among their three candidate properties. If they are unable to acquire their top two choices of identified candidate properties in time to meet their deadlines, the DST property serves as a backup option that can easily close in time to meet the exchange deadline.
  8. DSTs eliminate the capital gain tax on boot that many 1031 exchange investors do not like to pay when their replacement property costs less than the value of their relinquished property. DST interests tend to have lower acquisition prices than most worthwhile investment properties. Because of this, the remaining value, or boot, can sometimes be used to acquire a percentage of a DST property as a second replacement property in the 1031 exchange.
  9. Many investors view DSTs as investment opportunities that will benefit their heirs with a lasting generation of income once they have long passed on. The investors’ heirs will also receive a step-up in cost basis when they receive the DST assets (as with all 1031 exchange-qualified investments), meaning they will not have to inherit the previously deferred capital gain liabilities.
This is neither an offer to sell nor a solicitation of an offer to buy any offering from Pacific Oak. The above information is being provided solely for educational and informational purposes. Any securities offering is only made by prospectus or other appropriate offering document. This information must be provided in order to fully understand all of the implications and risks of the an offering. Neither the Attorney General of the State of New York nor any other state regulators have passed on or endorsed the merits of any Pacific Oak offering. Any representation to the contrary is unlawful. Investing in any security includes significant risks. These risks include, but are not limited to: the possibility of the loss of the entire investment; no guarantees regarding future performance; upon sale or distribution of assets, the potential receipt of less than the initial investment; fluctuation of the value of the assets owned; lack of a public market for shares; limited liquidity; limited transferability; reliance on the advisor to select, manage and dispose of assets; payment of significant fees; and various economic factors that may include changes in interest rates, laws, operating expenses, insurance costs and tenant turnover. Investments in securities are not appropriate for all individuals.