14 Reasons For Owners of Highly Appreciated Property to Use a Delaware Statutory Trust
Real Estate investing can be extremely rewarding financially. If you have succeeded in your prior real estate investment activities, you may be faced with a new challenge; how do you sell your property without paying income taxes, continue to receive monthly rental income and eventually any appreciation, yet not have to continue taking on the responsibility of property management? The following are examples of when, if you are an “Accredited Investor*”, a DST may be the solution you are looking for. Currently, REITs, partnerships and LLCs do not qualify for tax-deferral, but DSTs do qualify.
Retirement Strategy: Most investment property is currently owned by baby-boomers, or older people. Many of these investors need an exit strategy to fully retire and trade the Terrible T’s (tenants, toilets, trash, turmoil) for the Terrific T’s (travel, time, tax savings). DSTs provide a solution that enables the investor to list their investment properties for sale where previously they thought they were stuck due to income tax consequences.
Our investor (Mary) purchased 4 rental houses 30 years ago for $75k each, depreciated them fully, and now can net $250k each. These can be sold, and tax of $200k could be paid on the gains. The $800k net proceeds can be invested in a 1% CD earning $8k per year. Instead, it may be much better to invest in a DST using a 1031 exchange, the full $1 million may produce cash flow of $40k-$45k per year, no income taxes to pay upon the sale, and the investor still participates in underlying property value gains/losses.
Avoid Financing Obstacles
A Back-Up Plan
Let's return to our example investor: Mary found a small office building selling for $1 million as a suitable replacement. Within 45 days of the sale of the rental houses, she identifies this building. She also identifies 1 more property, a DST just in case the deal falls through.
Maintenance Costs on Older Properties
Example 4: 80-year old Frank called me with questions on his older 69-unit apartment. I asked him how much cash flow he kept per month, he said it was supposed be $6k after debt payments, but in reality, it was zero due to high repair costs. I informed him the DST would be in newer properties, offering initial cash flow of over $12k per month, with repair reserve monies already in place.
Unproductive Real Estate
Swap Until You Drop
This is best illustrated by the situation with Tom and Teresa are 80 years old and do a $1 million DST to defer a $900k taxable gain. Eight years later, this DST is sold and their share of the proceeds was $1.25 million. This is rolled into another DST. Tom passed away in the 6th year, and in the 7th year, this DST was sold yielding $1.5 million for Teresa. She can claim the step-up in basis, and eliminate virtually all-taxable gains from this property, as well as depreciation recapture taxes, permanently. She can put the $1.5 million in the bank, with no taxes, or she can do another DST and be eligible to use the new high basis for large depreciation deductions. In addition, while they owned the DST, additional accelerated depreciation was taken, reducing their taxes. The sponsor of the DST providing the accelerated depreciation used a “cost segregation study”.
Diversify, Diversify, Diversify
Local investors can be adversely affected. Take Bill for example. He felt good about the area where his rental house empire was situated, but concerned having all his eggs in a 10-block radius. In addition, prices had appreciated greatly, so he was concerned about being in a new real estate bubble. Using the DST, he is now partially invested in apartment buildings and medical office buildings in 5 different states.
Only 1 “Real Estate” Person in the Household:
Estate Planning Tool
A Retirement Plan
Investing Like Buffett
Fire, Imminent Domain, or Other Casualty
Brian Evans, CPA, PFS, is the portfolio manager of the Madrona Funds and owner of Madrona Financial Services and Bauer Evans CPAs.
Disclosure: Madrona Financial Services, LLC, and its Investment Advisers cannot and do not guarantee the performance of any investment or insurance product. Past performance is not a guarantee of future results.
*To be an accredited investor, an individual must have had earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years and “reasonably expects the same for the current year,” according to the SEC. Or, the individual must have a net worth of more than $1 million, either alone or together with a spouse. With the passage of the Dodd-Frank Act, this now excludes a primary residence as being eligible as part of an investor’s net worth (investors who had existing accredited investments but who now fail the net-worth test without their residence being valued were grandfathered).
The information, suggestions, and recommendations included in this material is for informational purposes only and cannot be relied upon for any financial, legal or insurance purposes. Madrona Financial Services will not be held responsible for any detrimental reliance you place on this information. It is agreed that use of this information shall be on an “as is” basis and entirely at your own risk. Additionally, Madrona Financial Services cannot and does not guarantee the performance of any investment or insurance product. Insurance products are offered through Madrona Insurance Services, LLC, a licensed insurance agency and affiliate of Madrona Financial Services. Madrona Insurance Services and individual advisors affiliated with Madrona Insurance Services and Madrona Financial Services receives commissions on the sale of insurance products. Clients are not required to purchase insurance products recommended or to otherwise implement financial advice through Madrona affiliates. When we refer to preparation and filing of tax returns, tax returns are prepared and filed by our wholly-owned sister company Bauer Evans, Inc. P.S., a licensed certified public accounting firm. Madrona Financial Services, LLC is a registered investment adviser with the SEC. Our registration with the SEC or with any state securities authority does not imply a certain level of skill or training. DST investments are only available to accredited investors and are offered solely through the issuers offering documents. The DST sponsor determines whether to accept any individual’s subscription documents.