Regret Waiting to Sell that Real Estate Investment Property?
By Johannes Ernharth, AIFA®
If the pandemic crisis is making you wish you’d not delayed your exit, 1031 Delaware Statutory Trusts may be a viable, tax-deferred alternative to lessen the cost of having waited.
For some time in the US, the COVID-19 Pandemic seemed to move in slow motion. But in what seems like just a matter of days, real estate and other investment decisions we thought had all sorts of time to be sorted out suddenly seem urgent. Equity markets dropped precipitously and became unprecedently volatile, while global credit and currency markets were exposed as unstable and illiquid. To some, once it began to unwind, it might even appear as if they may have regrettably “missed the boat”.
In retrospect, it might come easy to feel foolish for having not been more proactive, to have not procrastinated. You might even have regret for believing you could fetch a higher price by holding on to as an asset for just a bit longer. With rents and leases suddenly being cut and credit tightening, what are real estate investors supposed to do? What are the costs of exiting an investment property now going to be? How can owners limit their liability?
Of course, that answer is going to depend on each owner’s individual situation. But it’s also perfectly understandable that many with long-held properties have been avoiding the bitter pill of taxes triggered by a sale. When taxes can be up to 30% or higher, it’s not unreasonable that owners should have hesitated or delayed indefinitely the realization of large capital gains and substantial depreciation recapture – especially since few experts predicted COVID-19 could have such a dramatic impact just a few months ago.
For context, tax-aversion regularly causes investors to conclude that never selling is the better alternative to taxes. The plan often is to, instead, retain the property, divert its income to pay others to handle the business operations, and wait until a step-up of a tax basis occurs at the death of the owner.
Yet, with the economy suddenly hitting gridlock, there’s concern that market prices for real estate could drop substantially. That’s especially a concern if servicing debt. For those who now want to sell, adding in the unpleasant tax math only makes things feel more uncomfortable.
But there still may be a way to mitigate some of that pain and frustration. For those wanting to retire from active ownership and eliminate the burdens of related debt, there are alternatives to taxes or being stuck if the preference is to exit. One option, if suitable, might be using a 1031 Exchange into Delaware Statutory Trusts (DSTs) as eligible replacement property.
Through DSTs an investor can use the 1031 to exit the property they want to sell and defer taxes by swapping into ownership of DST held property. Investors become proportional owners of a passive investment vehicle, while the business operation of the real estate is professionally managed. Some DSTs offerings using leverage can permit shifting of outstanding debt obligations from an owner to the sponsors of the DSTs, while still maintaining the 1031 tax deferral on the amounts of retired debt.
Also, DST property can be as varied as investment real estate sectors and their geographic markets, and with minimums typically around $100,000, they may also provide greater diversification potential versus concentrated, active real estate positions. Given these lower limits, they can also permit partial downsizing, where an active property that’s sold can be partially swapped for a new, lower-cost active property with the remainder going to a diversified array of DSTs. The tax benefits of a 1031 can still be maintained even if the debt is retired!
DSTs are complicated investments with special risks and require full disclosure and consideration, as well as a very unique form of due diligence. For the right situations, the DST structure can be very useful for real estate investing. They can only be obtained through securities registered agents.
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The prior information is the views and opinions of Johannes Ernharth, AIFA©. Johannes specializes in DSTs for 1031s and has spent his career in Wealth Management and is a Senior Advisor for Asset Strategy Advisors (ASA) and Director of its Pittsburgh office.
This is for informational purposes only and does not constitute an offer to buy or sell any investment. DST 1031 properties are only available to accredited investors (typically have a $1 million net worth excluding primary residence or $200,000 income individually/
$300,000 jointly of the last three years) and accredited entities only. There are risks associated with investing in Delaware Statutory Trust (DST) and real estate investment properties including, but not limited to, loss of entire principal, declining market value, tenant vacancies and illiquidity. Diversification does not guarantee profits or guarantee protection against losses. Because investors situations and objectives vary this information is not intended to indicate suitability for any particular investor. This material is not to be interpreted as tax or legal advice. Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated. Advisory services offered through Asset Strategy Advisors, LLC (ASA), an SEC registered investment advisor. Securities offer through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Insurance services offered through Asset Strategy Financial Group, Inc. (ASFG). ASA, CIS and ASFG are separate companies.