COVID Economy derailed a 1031 Exchange?
Delaware Statutory Trusts may be a Potential Solution.
By Johannes Ernharth, AIFA®
Here’s the typical situation we’re seeing: Early this year, an owner received a great offer on his investment property, and the decision was made to sell using a 1031 exchange. The sale was closed just as COVID was slowing things down and the Qualified Intermediary now holds the proceeds.
That’s where the problems begin. Despite the 45-day deadline being extended due to the COVID emergency, suddenly the process of property acquisition has become comparatively difficult:
· Viewing properties and Inspecting was restricted due to stay-at-home orders and lock-downs around the country, with many states defining real estate as non-essential business
· Securing financing has become more difficult, jeopardizing tax deferrals. To maximize a 1031 exchange’s tax deferral, any debt that had been held on the relinquished property must be replaced with equal financing or additional cash contributions into the replacement property. With the crisis, the lending environment is in flux and lenders are being far more cautious, leaving some buyers unable to secure financing to complete their change.
IRS notice 2020-23 extended certain 1031 exchange deadlines to July 15, 2020 for any transaction that had its original deadline falling after March 31, 2020 and before July 15, 2020. Nevertheless, any deadlines that would ordinarily fall after July 15, 2020, presently remain calculated on their usual 45-day and 180-day deadlines. That’s increasingly problematic for those with the problems noted above.
Delaware Statutory Trust Solutions
Fortunately, there is a potential solution for those having a hard time finding property or qualifying for replacement debt! Delaware Statutory Trusts (DSTs)!
· When appropriate, DSTs may be a suitable backup to list alongside a property with concerns still outstanding that may not be resolved by 180-days. If they close on that property, that’s fine. If not, the DST will allow the investor to complete the 1031 and maintain the deferral.
· DSTs can be the first-choice for replacement in a 1031 Exchange if the property owner is looking to exit the responsibilities of managing their own investment property. Not only that, given their comparatively low minimums, the investor can achieve greater diversity with DSTs than replacing with a single property. When suitable, this can be a strategy for active property owners who want more passive investments so they can focus on family and retirement.
· When replacement debt is not an option and the buyer doesn’t wish to put additional cash equity into the 1031 to maximize the deferral, a DST may be an alternative. When a DST uses leverage on the property it owns, the DST investors are credited for the Loan to Value it implies for 1031 Exchange purposes. That also means those who want to exit the burdens of carrying debt on replacement property can use DSTs as an exit strategy.
One of the advantages of using DSTs is that the sponsor uses its full resources to do the due diligence on its property, including valuation and inspection. Professional management teams are already secured, and they handle securing and servicing debt. For a 1031 Exchange up against their 45-day window deadline, and providing Due Diligence has been done on the Sponsors and the DSTs, acquiring DSTs can often be closed in less than 72 hours.
If you’d like to learn more about DSTs, please download our DST Education Kit by clicking here. You can also sign up for one of our regularly offered DST webinars where you can learn more.