Russell Gullo, R. J. Gullo & Co., Inc.We all know today, the primary benefit of doing a “1031 exchange” is the opportunity to pay no tax. In many cases the taxes between capital gains, recapture of depreciation, medicare surtax and the state, can be as much as a third of the selling price.
So for those of you who like the benefits of real estate as an “investment,” but are tired of the day-to-day management, a “DST,” Delaware Statutory Trust property may be exactly what the doctor ordered.
So what is a “DST” Delaware Statutory Trust? A Delaware Statutory Trust is a separate legal entity created as a trust under the laws of Delaware in which each owner has a “beneficial interest” in the DST for Federal income tax purposes and is treated as owning an undivided fractional interest in the property.
Through the use of a “1031 exchange” because you have the opportunity to pay no tax you keep 100% of your equity working for you by reinvesting into a “replacement property.” With the use of leverage, in many cases you can double or even triple your real estate portfolio with the use of these tools.
By acquiring an income producing “DST” property, you may have an opportunity to increase your cash flow position from what you are receiving on your current property today. Over time you lose tax benefits from depreciation which is a paper loss and the interest expense from your mortgage which both create a tax shelter. As your equity position increases your tax sheltering decreases and your after-tax return should always be measured on your current equity position today and not the equity (down payment) used to acquire the asset.
One way to reduce your potential risk in investing in real estate is by rather then acquiring one property you acquire a diversified portfolio of properties in multiple locations. Instead of putting all your eggs into one basket.
When performing a “1031 exchange,” one of the requirements is that you go back into the same or greater amount of debt (mortgage) that you came out of in your “relinquished property.” Most owners coming out of their “relinquished property” will learn that the mortgage that they currently have is what’s called “recourse.” This means if you default, you are responsible to repay that debt.
In a “DST” property most sponsors are able to procure “non-recourse” financing, meaning if there is a default the debt would not have to be paid back by the “DST” investors. Typically a “DST” sponsor, because of their strong lending relationships, are able to secure this very favorable financing with very favorable terms in the marketplace.
“DST” investors are the direct recipient of these terms that they would otherwise often not be able to obtain on their own.
With a typical minimum capital investment amount of $100,000. “DST” investors are able to acquire a portion of a large, institutional-grade property or portfolio of properties that would normally be outside of their price point if they were to buy the whole asset by themselves.
One of the major advantages of acquiring co-ownership in a “DST” property, is to make sure you fulfill the “1031 exchange” requirements. Which includes both the 45-day “ID period” and the 180-day “exchange period.” Knowing that you may have the “replacement property” set, before coming out of the relinquished property” can save some sleepless nights.
Like any other investment, there are risks associated with “DST’s,” as well as requirements to qualify. Before investing in any investment vehicle you need to consult you tax and legal advisors, as well as speaking with a professional “qualified intermediary” before getting involved in this type of venture.
Russell Gullo, CCIM, CEA, is the CEO of R. J. Gullo Cos., West Seneca, N.Y.
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