Selling Investment Real Estate In Washington State? Consider a 1031 Exchange Into a DST (Delaware Statutory Trust)
Real estate attracts investors for many reasons, including tax advantages. Upon sale of investment real property, you are subject to capital gains tax. However, you may delay payment of that tax by quickly purchasing new real estate (a “replacement” property) after the sale of the original property. Section 1031 of the Internal Revenue Code sets forth the process, commonly known as a “1031 Exchange.” You may buy and sell real property using an unlimited number of 1031 Exchanges, delaying capital gains tax indefinitely. Investors frequently use the 1031 Exchange to their advantage in their estate planning, utilizing the step-up in basis for the benefit of their heirs.
While the 1031 Exchange can be a great option, it frequently presents problems. For example:
- The timeline is stringent – you must designate the replacement property within 45 of closing the sale of the original property. You must then close on the purchase of the replacement property within 180 days.
- The dollars likely will not match up, i.e. you will likely either have (i) more money out of the original property than you need to buy the replacement property, or (ii) not enough. The result? Either you pay some tax (in the first situation), or you find alternative sources of additional cash (in the second situation).
Investors sometimes elect to avoid this aggravation and risk by simply holding their properties longer than they should.
One possible solution to both problems: 1031 into a Delaware Statutory Trust (DST) instead of trying to find your own replacement property. In short, the DST allows the 1031 buyer to essentially own a fractional interest in a diversified portfolio of real estate, rather than being a landlord in the traditional sense. From your perspective as a 1031 buyer, the DST functions much like a REIT (real estate investment trust), a mutual fund, or an ETF. You simply hire a DST administrator prior to closing on the original property, work with the administrator to determine the best DST option for you, and follow the prescribed purchasing procedure. Like a regular investment property, the DST pays out rent to its investors on a regular basis, typically monthly. Here is more detailed DST information: https://www.1031exchange.com/delaware-statutory-trusts-an-innovative-1031-exchange-solution/
The DST solves both problems above. First, it eliminates your fire-drill: no designating and closing the replacement property within the tight 1031 timeline. Second, the DST allows you to invest virtually all the sale proceeds, with almost no overage or shortfall. Additionally – and for many investors most importantly – the DST can provide you a stream of rental income without the property-management hassle faced by the traditional landlord.
If you have questions about buying or selling investment real estate in Washington, including 1031 and DST issues, contact Beresford Booth at info@beresfordlaw.com or by phone at (425) 776-4100.