Selecting an appropriate replacement property is one of the most important, and sometimes one of the most difficult, parts of successfully completing a 1031 exchange. Many investors who no longer want to deal with the hassle of direct property management choose to purchase a Delaware Statutory Trust (DST) as their replacement property. This is known as a DST 1031 exchange.
The following guide will provide further information on the basics of how a DST 1031 exchange works and how it differs from a traditional 1031 exchange.
Important 1031 Exchange Deadlines
As with all 1031 exchanges, it’s critical to meet the deadlines set forth by the Internal Revenue Service. This includes the “45-day rule” and the “180-day rule.”
You’ll have 45 calendar days from the day you’ve transferred your relinquished property to unambiguously identify your replacement property. You also have 180 calendar days from the day your transfer your relinquished property to receive the replacement property.
It’s important to note that these timelines run concurrently. If you take the full 45 days to identify your replacement property, you’ll have 135 additional days to close on it. The deadlines are very strict, and it is extremely rare for the IRS to grant extensions. This is true even if the 45th day or 180th day falls on a weekend or legal holiday. For this reason, it’s critical to plan ahead and ensure you’ll meet the deadlines. Otherwise, you could cause your 1031 exchange to fail.
Using a DST as a Replacement Property
A 2004 IRS ruling distinguished DSTs from Limited Partnerships and established them as an acceptable replacement property for “like kind” 1031 exchanges. The structure of a DST allows a pool of investors to purchase fractional shares of real estate property that is owned by the trust, giving them a “beneficial interest.”
This allows investors to receive potential passive income and appreciation from their investment without having to worry
about acquiring the properties, managing debt, or keeping up with property maintenance. In fact, all decision-making power is granted to the DST’s trustee, completely freeing investors from active engagement.
There are many potential advantages of using a DST for your 1031 exchange. One is the ease of purchase. Unforeseen circumstances may delay a direct real estate purchase and could cause you to miss a critical deadline. However, purchasing a DST is typically a straightforward process with few, if any, delays.
Identifying Your Replacement Property
Whether you choose to use a DST or a direct real estate investment, you must identify your replacement property in writing to meet the requirements of the 45-day rule. To do this, you’ll need to follow one of three rules:
- Three Property Rule
- 200% Rule
- 95% Rule
The Three Property Rule states that an exchanger may identify up to three potential replacement properties with no regard to the value of the properties identified. The 200% rule allows you to identify an unlimited number of properties as long as the aggregate value is no more than 200% of the value of the relinquished property. The 95% rule allows you to identify an unlimited number of properties as long as you acquire at least 95% of the value of the identified properties.
This is where it gets a bit tricky. When identifying a DST as your replacement property, it’s generally recommended that you identify each property held by the DST. For example, if you purchase a DST that holds 12 drugstores in six different states, this will count as 12 replacement properties.
Consult with Your Tax and Legal Advisors
Tax and legal advisors often have differing recommendations regarding the proper way to identify a DST 1031 exchange replacement property. Some may be comfortable with simply identifying the percentage of the DST you intend to hold. Others may prefer to identify the fractional interest of the DST or the dollar amount of equity that will be used to make the purchase.
Due to the complexity of identifying a DST as a replacement property, you’ll always want to consult with tax and legal experts who are well-versed in the intricacies of DST 1031 exchanges. This will help you avoid unintentional identification errors which could result in a failed DST transaction.
If you would like to learn more about how to use a DST as a replacement property for a 1031 exchange, the professionals at Bangerter Financial are here to help. To get started, contact us online or give us a call at 916-965-1879.
If you would like to learn more about how to use a DST as a replacement property, take a look at our complementary eBook, “Using DSTs for a 1031 Exchange”. It contains a wealth of important information including an overview of the most common types of DSTs, benefits and risks to consider, and more. Download your copy today!
This is for informational purposes only, does not constitute individual investment advice, and should not be relied upon as tax or legal advice. Please consult the appropriate professional regarding your individual circumstance.
Because investor situations and objectives vary this information is not intended to indicate suitability or a recommendation for any individual investor.
Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated.
There are material risks associated with investing in DST properties and real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal. Past performance is not a guarantee of future results. Potential cash flow, returns and appreciation are not guaranteed. IRC Section 1031 is a complex tax concept; consult your legal or tax professional regarding the specifics of your particular situation. This is not a solicitation or an offer to sell any securities. 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. If you are unsure if you are an accredited investor and/or an accredited entity please verify with your CPA and Attorney.
Investment advisory services offered through Bangerter Financial Services, Inc. A state Registered Investment Advisor. Registered Representative and securities offered through Concorde Investment Services, Inc. (CIS), member FINRA/SIPC. Bangerter Financial Services, Inc. is independent of CIS