Opportunity Zone / 1031 Exchange Strategies
Many business owners who hold highly appreciated real estate assets may be at a stage of their lives when they are seeking more passive (yet tax-efficient) investment opportunities. Passive, professionally managed ownership may allow them to concentrate on other opportunities in life that they may have always been passionate about but never had the time to thoroughly enjoy.
A 1031 Exchange allows deferred recognition of capital gains and related Federal income tax liability on the exchange of certain types of like kind property.
Delaware Statutory Trusts
Though Delaware Statutory Trusts (DST) are not new, current tax laws have made them a preferred investment vehicle for passive 1031 Exchange investors and direct (non-1031) investors alike.
DSTs are derived from Delaware Statutory law as a separate legal entity, created as a trust, which qualifies under Section 1031 as a tax-deferred exchange. In 2004, the IRS blessed DSTs with an official Revenue Ruling about how to structure a DST that will qualify as replacement property for 1031 Exchanges.
The Revenue Ruling (Rev. Ruling 2004-86) permits the DST to own 100 percent of the fee-simple interest in the underlying real estate and may allow up to 100 investors — sometimes more — to participate as beneficial owners of the property.
How DSTs Work
The real estate sponsor firm, which also serves as the master tenant, simply acquires the property under the DST umbrella and opens up the trust for potential investors to purchase a beneficial interest.
The investors may either deposit their 1031 exchange proceeds into the DST or the investor may purchase an interest in the DST directly.
DST investors may benefit from a professionally managed, potentially institutional quality property. The underlying property could be a 500-unit apartment building, a 100,000 square-foot medical office property or a shopping center leased to investment-grade tenants. The possibilities are endless.
Most DST investments are assets that your run-of-the-mill, small- to mid-sized accredited investors could not otherwise afford. However, by pooling money with other investors, they can acquire this type of asset.
DSTs are not without risks. As with any type of real estate investment, investors may be subject to high vacancy rates and loan defaults.
DSTs are also not sole-ownership investments. A DST is a more passive investment made up of multiple owners and ultimately controlled by the master tenant — the sponsor. The DST structure may be a viable investment alternative for qualified real estate investors.