Real estate investment in New York comes in many forms, giving investors a variety of options. Some investment opportunities require substantial oversight, while others do not. Additionally, real estate investment involves many tax considerations, and investors are typically looking for an option that will limit tax liability, which is where the 1031 exchange comes in.
For more information on how the holding period works and deferring taxable gains using 1031 exchanges, speak with an experienced New York City 1031 exchange lawyer. At Sishodia PLLC, our lawyers are well-versed in the local market and can assist you with a wide range of real estate matters, including tax considerations, 1031 exchanges, contract negotiations, due diligence, and compliance. Don’t face complex real estate investment transactions alone – Contact us at (833) 616-4646 for personalized solutions tailored to your specific needs and goals.
What is a 1031 Exchange?
In the world of real estate, a 1031 exchange refers to a swap/exchange of property that is held specifically for business or investment purposes.
Per IRS code section 1031, an investor can swap one investment property for another like-kind (tax-deferred transaction) investment property to avoid paying taxes on capital gains on the sale of the property. There is also no limit on how many times or how frequently investors can do 1031 exchanges.
While 1031 exchanges alone are beneficial to many investors, meeting IRS requirements can be difficult without the help of others, which is why many investors are turning to the Delaware Statutory Trust (DST) to do 1031 exchanges.
Understanding Delaware Statutory Trusts (DSTs)
A Delaware Statutory Trust (DST) is a legal entity that is recognized as a trust established for the purpose of conducting business. Although the name implies a DST may only apply in the state of Delaware, DST is a term used to describe a similar type of entity in any state, which is also termed “Unincorporated Business Trust”. DSTs are often used for real estate investments and have become popular for 1031 exchanges. DSTs often own multiple high-value properties.
In Rev Rul 2004-86, the IRS ruled that a taxpayer may exchange real property for an interest in the Delaware Statutory Trust without recognition of gain or loss under § 1031 if the other requirements of § 1031 are satisfied. The IRS considers DSTs as qualified real estate, which means that a DST could serve as “replacement” property for purposes of a 1031 exchange. Instead of playing a larger role in real estate investment deals, many investors choose to acquire fractional interests in a DST. In doing so, investors can often avoid the headaches of rental property ownership.
What Is a DST in Real Estate?
A Delaware Statutory Trust (DST) is a way for multiple investors to collectively own real estate. Each investor owns a piece of the entire property, sharing in the profits and responsibilities without managing the property directly.
The creation of a DST is handled by a real estate company, known as a DST sponsor. This sponsor is responsible for selecting and buying the real estate properties that will be part of the trust. Once the properties are acquired, they are managed by the sponsor, allowing investors to benefit from ownership without the hassles of property management.
This investment structure is particularly appealing for those looking to invest in real estate collectively, offering a more passive approach while still participating in the potential financial benefits.
1031 Exchange for Foreign Property
The rules governing international 1031 exchanges can be summarized as follows:
- A property located in the United States can be exchanged for another property within the United States.
- A property located in a foreign country can be exchanged for another property within that same foreign country.
- However, a property located in the United States cannot be exchanged for a property in a foreign country.
Therefore, the key requirement for a 1031 exchange is that the properties involved must be situated in the same country.
Investors have the option to utilize a 1031 exchange to defer capital gains tax on the sale of real estate in a foreign country. However, this choice introduces additional complexities for investors who already own foreign properties. In addition to the standard considerations for a 1031 exchange, such investors need to navigate additional challenges, including tax obligations in the foreign country and the process of converting currency from USD to the local currency. Furthermore, when conducting a 1031 exchange in an international context, the replacement property must also be situated in a foreign country. Hence, careful attention must be given to ensuring compliance with tax laws and regulations in both the investor’s home country and the foreign country involved in the exchange.
To receive proper guidance on structuring a 1031 exchange and navigating the specific rules and requirements that apply to your situation, it is important to consult with a qualified New York City 1031 lawyer. Schedule a consultation with Sishodia PLLC today for assistance.
Benefits of Delaware Statutory Trusts
Advantages of investing in Delaware Statutory Trusts include the ability to reduce, eliminate or even eliminate taxes on the sale of investment properties using a 1031 Exchange. DSTs are also a popular passive real estate investment offering ownership in institutional-quality properties with minimal landlord responsibilities. Delaware Statutory Trusts have many advantages or benefits, including 1031 Exchange replacement properties. These advantages or benefits include:
- Capital Gains Tax Savings
- Higher Income Potential
- Institutional-Grade Properties
- Passive property management
- Risk Diversification
- Tax Savings for Estate Beneficiaries
- Low risk of exchange failure
- Ability to be Closed in 3 to 5 days
Disadvantages of a 1031 Exchange Delaware Statutory Trust
As with all real estate investments, investing in Delaware Statutory Trusts comes with many disadvantages or risks. There is the possibility of losing principal and a lack of return. DST is an income-focused investment that can be long-term and dependent on the ability of tenants to pay rent. This DST risk includes lack of liquidity, interest rates risk, and changing market conditions. Some DST characteristics may not be compatible with individual investment goals, such as the inability to control the investment.
Accessing Diverse Commercial Real Estate through DSTs
Delaware Statutory Trusts (DSTs) offer individual investors an unprecedented opportunity to access a diverse range of commercial real estate (CRE) options that are typically financially inaccessible to them. By pooling resources, investors can acquire shares in a trust that holds large-scale, institutional-quality real estate, spanning from multifamily complexes to retail spaces, and from industrial warehouses to office buildings.
For investors looking to diversify their portfolio beyond the volatility of the stock market, DSTs provide a gateway to the stable returns and potential appreciation associated with CRE. The investment is not just about diversification, but also about the potential for competitive income streams from assets like a fully leased Amazon fulfillment center or a multifamily property in a prime location.
An integral component of the DST’s appeal is its alignment with the 1031 Exchange rules. DSTs qualify for these exchanges, allowing investors to defer capital gains taxes by reinvesting the proceeds from sold properties into “like-kind” real estate within a set timeframe. This tax advantage preserves the equity of their investment, enabling it to continue working for the investor in their new property.
Moreover, DSTs offer a solution to the often prohibitive time constraints of 1031 Exchanges. With DSTs often closing within a few business days, they provide a substantial benefit over traditional real estate transactions, which can be delayed due to various factors and thus risk breaching the 1031 Exchange’s strict deadlines.
Finding 1031 Exchange DST Properties
The national institutional real estate companies referred to collectively as “DST sponsors” are responsible for vetting and acquiring properties within every Delaware Statutory Trust. After the DST property is acquired, several parties do due diligence on the trust structure and property. DST sponsors package the DST offering and brings it to market through independent brokerages that have the necessary securities licenses to transact DSTs for clients.
DSTs can have one or more properties. Each DST will usually own one type of property. DSTs typically own institutional property of high quality, which can lead to higher income and potential appreciation. One DST might own multifamily apartments in a class A category, while another DST could own an industrial building such as an Amazon Distribution Center, or net lease real property with corporate guaranteed retail tenants such as Walgreens and Whole Foods.
Finding a DST is the biggest obstacle to investing in it. SEC regulations prevent all DST investments from being sold directly to the general public. DST sponsors work directly alongside securities brokers-dealers and 1031 Exchange Advisors in order to make their offerings available to accredited investors.
Turning Your 1031 Exchange Property into a Delaware Statutory Trust (DST)
To benefit from DSTs, investors can sell the original investment property for an interest in a DST and become a fractional investor alongside other owners/investors. By choosing to transfer ownership from a 1031 property into a DST, the investor/property owner is no longer responsible for the burdens of managing the 1031 property. Also, having a fractional ownership interest in a DST provides investors with a diversified portfolio and passive income-producing property that allows them to continue deferring taxes on capital gains stemming from the sale of the original property.
| Things to Know about Delaware Statutory Trusts | Details |
|---|---|
| Definition and Purpose | DSTs are legal entities for real estate investments, commonly used for 1031 exchanges. |
| Advantages | DSTs offer tax savings, higher income potential, passive management, risk diversification, and estate tax benefits. |
| Disadvantages | Considerations include potential loss of principal, limited liquidity, income dependence, and reduced control over the investment. |
| Finding DST Properties | DST sponsors work with brokers to offer DST interests, vetting suitable properties for accredited investors. |
| 1031 Exchange Property Transition | Investors can transition to DST interests, gaining fractional ownership, diversification, and passive income potential. |
Why You Should Consult with a New York 1031 Lawyer?
Understanding IRS rules and regulations can be difficult for even a well-versed investor. Whether you are a buyer or a seller, trying to master and know how to take advantage of IRS Code section 1031 by utilizing a DST can be a complicated task. While online materials can be useful, nothing is as helpful as speaking with a legal professional who focuses on real estate matters in New York. Enlist the help of a New York real estate lawyer who can navigate you through tax laws, simplify the process for you, and help you avoid risks.
Contact Sishodia PLLC today online or by calling (833) 616-4646 to speak with a reputable 1031 exchange attorney to learn more about your real estate investment options.
