A: Bill wrote, “Dear Derek, I have always been a real estate investor. However, I have reached a point in my life where I no longer want to be a landlord. Is there something out there where I could maintain my basis, income, and tax benefits, but not have to deal with the “toilets, tenants, and distractions?”
Q: That answer is “YES!” Bill there is an alternative that might be a positive fit for your desires. I can’t tell you how many clients fit your profile and share your same goal. Real estate is a wonderful asset class with numerous tax benefits. It is a great way to build long-term income and wealth for you and your family. Below I will discuss an alternative that will afford you the tax-deferral you desire while maintaining or increase your current income. You will see that in many cases that if designed properly you can shelter most of this income and eliminate the responsibilities associated with being a landlord in your retirement.
On August 16, 2004, Internal Revenue Bulletin 2004-33 was published in reference to Rev. Rul. 2004-86. This established what is called a Delaware Statutory Trust (herein referred to as a “DST”). Please don’t get caught up in the concept of a trust and the State of Delaware. A Delaware statutory trust (DST) is a legally recognized trust that is set up for the purpose of the business but not necessarily in the U.S. state of Delaware. It may also be referred to as an Unincorporated Business Trust.
DST Investments are offered as replacement property for accredited investors seeking to defer their capital gains taxes through the use of a 1031 tax deferred exchange and as straight cash investments for those wishing to diversify their real estate holdings. DSTs investors must be an accredited investor. That means that to be an accredited investor, an individual must have had earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years and “reasonably expects the same for the current year,” according to the SEC. Or, the individual must have a net worth of more than $1 million, either alone or together with a spouse. With the passage of the Dodd-Frank Act, this now excludes a primary residence as being eligible as part of an investor’s net worth (investors who had existing accredited investments but who now fail the net-worth test without their residence being valued were grandfathered).
If you meet those qualifications, a DST may be an option for you. From the perspective of an individual investor, perhaps the biggest benefit of the DST structure is that it allows a fractional interest in real estate interests to qualify as a like-kind property for exchange purposes. In turn, this opens several investment possibilities that may not have been available to the investor. An investor who owned and managed a single-family home for example may roll the proceeds from the sale of that property, into a new investment class such as industrial, multi-family housing or office space through the purchase of a fractional investment.
I often see long-term real estate owners who have personally performed their own property management activities decide to retire and struggle to maintain the necessary tasks related to the ownership of numerous properties. The true benefits of a DST investment are the following:
- The owner can maintain his basis in the new property;
- The owner can defer all capital gain tax liability;
- The owner, if properly advised and the transaction is properly designed, can defer or eliminate all taxation on the “boot” related to the exchange into a DST. This significant because the pay of indebtedness related to the old property can become taxable to the owner as an income tax liability and is often taxed at the highest income tax rates;
- The owner often times inherits a new depreciation schedule that can often assist them in offsetting future income;
- The owner can better design their estate and wealth transfer plan because they receive individual shares as a part of their ownership;
- The owner can diversify more greatly meaning they may sale their one large property and diversify their new DST investment geographically in high-growth markets around the country, as well as, across many real estate sectors, such as self-storage, hospitality, industrial, medical, and other secure classes within the DST.
- The owner can mitigate their income risk by investing in multiple DST and avoid the sole dependence on having owned only one or two properties.
If you would like to learn more about the potential benefits of DSTs and how they might work best for your wealth management purposes, please do not hesitate to email me at firstname.lastname@example.org I would be happy to discuss this topic in-depth with you.