Section 1031 and Delaware Statutory Trusts
February 6, 2017
How many of us own rental properties that we keep for many years, yet have no debt liabilities, and have made few bucks from rental income? If you have read this far, you probably have. Now the bigger question for those of you who have sold investment property over the years is how many of you have sheltered your gains on the property upon disposition using Internal Revenue Code Section 1031, particularly in a Delaware Statutory Trust?
Internal Revenue Code Section 1031
Internal Revenue Code Section 1031, or as it is more commonly known, the 1031 Exchange originated in 1921 and simply states that no gain or loss is recognized when property held for productive use in trade, business, or for investment, when it is exchanged for like-kind property also to be held for productive use in trade, business, or for investment.
Section 1031 has its genesis in the simultaneous transfer of land that was used throughout the farming community to allow farming families to “trade” odd shaped lots making it easier for them to sow their land, and deliver more goods to market in a more efficient manner.
Throughout the years, Section 1031 has been amended several times, but it wasn’t until many years, following the initial draft in 1921, that the immediacy of the transaction was challenged. The delayed exchange was created and today’s more practical application of Section 1031 was put to use for all investment real estate owners. The modifications to this section of the Internal Revenue code now allows the real estate investor to maximize their income and appreciation opportunities, and where necessary the depreciation and tax loss benefits of owning investment real estate assets.
Section 1031 allows the exchanger to defer indefinitely the capital gains and depreciation recapture liabilities when they sell one investment property for another within a defined period of time and by meeting certain federally regulated guidelines. But what impact could this deferral mechanism have for the exchanger? To understand exactly how much of their capital is exposed when disposing of an asset. Section 1031 allows for the deferral of all immediate taxable liability indefinitely, keeping their capital at work.
Related post: Executing a 1031 Exchange
Internal Revenue Code Section 1031 has been on the books for over 70 years and it stipulates that “no gain or loss is recognized when property held for productive use in trade or business, or for investment, is exchanged for like-kind property to be held for productive use in trade or business, or for investment.” With an investment in real estate, this opens an opportunity for you as the investor to get out of lower income producing, management intensive real estate, defer ALL the gain and recapture liabilities and have the opportunity to potentially “trade-up.” Many of you who own investment real estate probably are completely unaware of this option, or have chosen not to use it because you feel that if you sell one rental your only option under like-kind rules is to buy another. If that is the mentality, then you probably feel a new management headache is going to feel very similar to the existing one. But, what if you could find a like-kind replacement property solution that would eliminate those headaches, increase your overall value, lower your investment risk exposure and provide a current stream of income potentially greater than what you have today?
Delaware Statutory Trusts
A replacement property solution that is becoming increasingly popular for real estate investors and 1031 exchangers is the Delaware Statutory Trust (DST). A DST is a legal entity created as a trust under Delaware law that can hold real estate. In 2004 under IRS Revenue Bulletin 2004-33, the Delaware Statutory Trust, or DST, was permitted to qualify as a vehicle for like-kind replacement properties as part of an investor’s 1031 exchange. The ruling permitted the use of the fractional ownership used in the structure of a DST.
How Does a DST Work?
The sponsor company, which usually serves as the master tenant, acquires the property under a Delaware Statutory Trust and opens up the trust for investors to purchase a beneficial interest. The investors have the option to either deposit their 1031 exchange proceeds into the DST or to purchase an interest directly. For investors with management intensive properties that are becoming a larger burden than reward, a DST could make sense. Delaware Statutory Trusts can open the doors for a diverse portfolio of professionally managed, high quality property. The property could be a state-of-the-art medical office building or a 300-unit multifamily apartment complex. The opportunities are vast and available.
Since a great deal of Delaware Statutory Trust programs are offered as Private Placement Securities, investors must meet one or more of the accreditation standards. Investors must either have a net worth of $1 million (or more) or household income of $200,000 if filing as single or $300,000 if married and filing as join for the preceding 2 years with a reasonable expectation to continue. If the investor does not meet those levels, there are also accreditation standards based on level of sophistication, occupation or based on investment amounts. Prospective investors should consult their financial advisor or other financial professional for more on accreditation standards.
Are you in search of a 1031 Exchange replacement property, particularly a DST? We have dozens of institutional-grade 1031 Exchange properties to choose from. Sign up for a free account to view our current inventory.
Please note: 1031RPS.com and its associated personnel are not tax professionals, and they recommend investors consult with their tax advisor to ensure their 1031 Exchange is within the IRS guidelines established.