By The Kay Properties Team
People just beginning to explore commercial real estate investing opportunities often have questions about the different types of real estate ownership structures and specific tax benefits that may be available to them. Our specialty at Kay Properties is Delaware Statutory Trust 1031 Exchanges. But just what are DSTs and 1031s? This blog post offers some basic facts and explains how they can work together to benefit investors.
What is a Delaware Statutory Trust?
A Delaware Statutory Trust (DST) is an entity used to hold title to investments, including income-producing real estate. Most types of real estate can be owned in a DST, including retail, office and multifamily properties.
There can be up to 499 individual investors in a DST. Each investor holds an undivided fractional interest in the property. Decision-making authority typically rests with a trustee who is an experienced asset manager designated by the sponsor of the offering. The sponsor also can be an investor in the DST. A DST is considered a security and is governed by securities laws.
Owners of a DST receive an operating statement at the end of the year showing their pro-rata portion of property income and expenses, in the same way that they would with any other commercial or rental properties that they may own directly.
What is a 1031 Like-Kind Exchange?
One of the most attractive real estate tax benefits available in the U.S. is the like-kind exchange, which is governed by Section 1031 of the Internal Revenue Code. A like-kind exchange allows an investor to defer taxes on capital gains and depreciation recapture at the time a real property investment is sold if the net equity from the sale is reinvested into a similar property of the same or greater value.
According to the Internal Revenue Service: “Properties are of like-kind if they’re of the same nature or character, even if they differ in grade or quality. Real properties generally are of like-kind, regardless of whether they’re improved or unimproved.” For example, an apartment building could be exchanged into a warehouse, a warehouse into a piece of raw land, a piece of raw land into a single-family rental property, etc. As long as the property is held for investment or business purposes, it is considered like-kind.
As a result of 1031-exchange investing, the initial invested capital and the gain can continue to grow, potentially, without immediate tax consequences. Then, if and when the new investment is sold without the equity reinvested in another exchange property, the prior gain is recognized. Investors should consult their tax or legal advisors prior to selling or exchanging a property, as everyone’s tax situation is different.
How can a DST and 1031 exchange work together?
Not all properties qualify as like-kind exchange replacement properties under the Internal Revenue Code. But a DST property does. A person can invest into a DST property to qualify for the tax treatment when they sell their interest, or invest out of a DST into another DST or another property of like-kind (Internal Revenue Code Ruling 2004-86). As noted above, this is general information. Investors should consult their tax or legal advisors prior to investing in, selling or exchanging a property, as everyone’s tax situation is different.