1031 Exchanges to Defer Capital Gains and Build Wealth with DSTs

A 1031 exchange is a swap of one real estate investment property for another that allows capital gains taxes to be deferred. The term gets its name from Section 1031 of the Internal Revenue Code (IRC).  

• A 1031 exchange is a tax break. You can sell a property held for business or investment purposes and swap it for a new one that you purchase for the same purpose, allowing you to defer capital gains tax on the sale.
• Proceeds from the sale must be held in escrow by a third party, then used to buy the new property; you cannot receive them, even temporarily.
• The properties being exchanged must be considered like-kind in the eyes of the IRS for capital gains taxes to be deferred.
• If used correctly, there is no limit on how frequently you can do 1031 exchanges.
• The rules can apply to a former principal residence under very specific conditions.
• DST investments are speculative, illiquid and involve a high degree of risk.

The DST property ownership structure allows the smaller investor to own a fractional interest in large, institutional quality and professionally managed commercial property along with other investors, not as limited partners, but as individual owners within a Trust. Each owner receives their percentage share of the cash flow income, tax benefits, and appreciation, if any, of the entire property. DSTs provide the investor the potential for annual appreciation and depreciation (tax shelter), and most have minimum investments, allowing some investors the benefit of diversification into several properties.

The DST ownership option essentially offers the same benefits and risks that an investor would receive as a single large-scale investment property owner, but without the management responsibility. Each DST property asset is managed by professional investment real estate asset managers and property managers. It used to be that only large institutional investors such as life insurance companies, pension funds, real estate investment trusts (REITS), college endowments and foundations were able to invest in these properties. Now as a viable 1031 exchange replacement property option through a DST, individual investors have the ability to invest in a diversified selection of institutional quality, investment property types that they otherwise could not purchase individually. DST Investments are located throughout the United States. Property types may include multifamily apartment communities, office buildings, industrial properties, multi-tenant retail, student housing, assisted living, self-storage facilities, medical office, single tenant retail properties and others. 

Although a DST investment can help in many ways it is also important to remember that they are real estate investments which are speculative, illiquid and involve a high degree of risk.  Please consider your risk tolerance and get a complete understanding before investing in a DST.

There are two key timing rules that you must observe in a delayed exchange:

45-Day Rule
The first timing rule relates to the designation of a replacement property. Once the sale of your property occurs, the intermediary will receive the cash. You can’t receive the cash or it will spoil the 1031 treatment. Also, within 45 days of the sale of your property, you must designate the replacement property in writing to the intermediary, specifying the property that you want to acquire.  

The IRS says you can designate three properties as long as you eventually close on one of them. You can even designate more than three if they fall within certain valuation tests.

180-Day Rule
The second timing rule in a delayed exchange relates to closing. You must close on the new property within 180 days of the sale of the old property.