FREQUENTLY ASKED QUESTIONS
Get Answers to the Most Common Questions About 1031 DST Strategies
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A 1031 exchange is a strategy for deferring the capital gains tax from the sale of an investment or business property. By exchanging a relinquished property for like-kind real estate, owners may be able to defer their federal taxes and use the proceeds for the purchase of replacement property.
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Generally this refers to any form of property held for business or investment purposes including: apartment buildings, single-family rentals, vacant land, office buildings, self-storage facilities, shopping centers, and hotels. These property types may be 1031 eligible properties.
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Not all real estate investments are eligible for 1031 exchanges. In order for an investment in real property to be 1031 eligible the individual must have a direct ownership in the underlying real estate. Debt investments are not eligible because they are interests in a promissory note, not the underlying real estate. Similarly, partnership interests (including LLC’s) where an investor owns a share of a partnership interest instead of a share of the underlying real estate would be ineligible. However, per the IRS’s Revenue Ruling 2004-86, ownership of a beneficiary interest in a Delaware Statutory Trust does qualify to be part of an investor’s 1031 Exchange.
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Commonly known as a “DST”, this entity is often used to hold title to real estate similar to an LLC. Instead of owning a membership interest in an LLC, a DST investor owns a beneficial interest in the DST. Also like an LLC, the entity shields the investor from individual liability. However, unlike an LLC, a DST 1031 property will qualify as a “like kind” exchange replacement property for a 1031 exchange per the Internal Revenue Ruling 2004-86.
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The DST is typically managed by the DST Trustee and the beneficial owners do not have voting rights like they would typically have in an LLC. Instead the DST and therefore the real property investments held by the DST are managed by the Trustee, not the investors themselves. Additionally, the IRS established seven prohibitions over the powers of the DST Trustee, which includes the following:
• Once the offering is closed, there can be no future equity contribution to the DST by either current or new co-investors or beneficiaries.
• The DST Trustee cannot renegotiate the terms of the existing loans, nor can it borrow any new funds from any other lender or party.
• The DST Trustee cannot reinvest the proceeds from the sale of its investment real estate.
• The DST Trustee is limited to making capital expenditures with respect to the property to those for a) normal repair and maintenance, (b) minor non-structural capital improvements, and (c) those required by law.
• Any liquid cash held in the DST between distribution dates can only be invested in short-term debt obligations.
• All cash, other than necessary reserves, must be distributed to the co-investors or beneficiaries on a current basis, and
• The Trustee cannot enter into new leases or renegotiate the current leases.
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DST Agreements often contain a provision that allows the Trustee to convert the DST to an LLC (the “Springing LLC”) if the Trustee determines that the DST is in danger of losing the property due to its inability to act because of the prohibitions in the trust agreement. The conversion to an LLC will allow the Trustee, who becomes the Manager of the LLC to raise additional funds, renegotiate terms of existing debt, and enter into new leases. However, because a membership interest in a Springing LLC is not a 1031 eligible, the members (investors) lose their ability to defer capital gains upon the sale of the property owned by the LLC through another 1031 exchange.
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The following is a list of the basic elements involved in typical 1031 Exchanges:
o • A Qualified Intermediary, sometimes referred to as a “1031 Accommodator” or QI is used to exchange the funds from the real estate that is sold to the real estate that is purchased.
• Investors identify their replacement properties (typically spell out properties) with their 1031 Accommodator within 45 days of sale of the initial property.
• Investors reinvest 100% of the net sales proceeds from the initial property sale into their replacement properties.
• Investors acquire an equal or greater amount of debt on the replacement properties than they had on their initial properties.
• Investors close on the purchase of the replacement properties within 180 days of the sale of their initial property.
• 1031 Exchanges can be very complicated and an investor should consult with their CPA and attorney before proceeding with an exchange.
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Yes. “Cash Investors” are investors who use non-1031 money to invest in a 1031 eligible deal. Once they have completed their investment, those investment funds become 1031 eligible and can be used as part of a 1031 exchange in the future.
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Tax is calculated upon the taxable gain. Gain and equity are two separate and distinct items. To determine your gain, identify your original purchase price, deduct any depreciation, which has been previously reported, then add the value of any improvements, which have been made to the property. The resulting figure will reflect the cost or tax basis. The gain is then calculated by subtracting the cost basis from the net sales price.
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Yes, although they can sometimes become complex and always require appropriate planning. Most of our qualified I ntermediary or facilitator partners (make Qualified Intermediaty lower case unless it’s QI) are owned by banks. This means that in st cases they will not handle reverse 1031 exchanges because liability reasons prevent them from holding title to property on behalf of an exchanger. 1031 Crowdfunding, LLC suggests contacting one of our Partners for a reverse 1031 exchange planning and execution. They have demonstrated its unique planning and execution capabilities over a course of several years and work closely with the most experienced tax attorneys in the country.
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While a like-kind exchange does not have to be a simultaneous swap of properties, the investor must meet two time limits or the entire gain will be taxable. These limits cannot be extended for any circumstance or hardship except in the case of presidentially declared disasters.
Indent here: The first limit is that the seller has 45 days from the date of the sale of the the relinquished property to identify potential replacement properties. The identification must be in writing, signed by the seller and delivered to a person involved in the exchange like the seller of the replacement property or the qualified intermediary. However, a notice to the attorney, real estate agent, and accountant or similar persons acting as the agent is not sufficie sufficient.
Replacement properties must be clearly described in the written identification. In the case of real estate, this means a legal description, street address or distinguishable name. Follow the IRS guidelines for the maximum number and value of properties that can be identified.
The second limit is that the replacement property must be received and the exchange completed no later than 180 days after the sale of the exchanged property or the due date (with extensions) of the income tax return for the tax year in which the relinquished property was sold, whichever is earlier. The replacement property received must be substantially the same as property identified within the 45-day limit described above.
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This is another exchanging myth. There are no provisions within either the Internal Revenue Code or the treasury regulations which restrict the amount of properties which can be involved in an exchange. Therefore, exchanging out of several properties into one replacement property or vice versa, relinquishing (selling) one property and acquiring several are perfectly acceptable strategies.
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Identifications may be made to any party listed above. However, many times the escrow holder or closer is not equipped to receive the identification if they have not yet opened a transaction file. Therefore, it is easier and safer to identify through the qualified intermediary or facilitator provided the identification is postmarked or received within the forty-five-day identification period.
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No, although there was a time when all exchanges had to be closed on a simultaneous basis, they are rarely completed in this format any longer. In fact, a significant majority of exchanges are now closed as delayed or deferred exchanges.
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