This blog post is the second part of a two-part series — see The Decision Tree Problem Investors Face in a Hot Market for part one.
If you cannot identify and close on a 1031 exchange, then you may want to consider a DST. A DST is a Delaware Statutory Trust. These trusts allow passive, fractional ownership in real estate while qualifying as a “Like-Kind” exchange replacement property under Section 1031 of 26 USC.
Some of the benefits of a DST are that it allows you to invest in institutional-grade properties, provides you with diversification, provides passive investment, helps you realize income and appreciation, is tax-advantaged, and is an excellent alternative to the 1031 exchange if you cannot identify and close within the time restrictions.
This investment generally allows a relatively low minimum investment, thereby allowing investors access to institutional-grade properties that they otherwise could not invest in on their own. These asset classes range from multifamily properties to hotels to TNL office space, student housing, and the list goes on. Such investments are not typically open to mom-and-pop investors.
Additionally, the above-listed property types provide a passive investment. No more hands-on management. By lifting this burden off of the investor, those investors are now free to use that time more efficiently in their investment activities with the knowledge that their money and properties are in the hands of professional management. This benefit leads to the next benefit of passive investment.
With professional management, the investor is now truly a passive investor. What had traditionally been very active and hands-on investment participation has now become the job of a professional management company to handle the day-to-day tasks of property management and care. Professional management also leads to stable operating cash flow that often leads to immediate cash flow for investors.
The tax benefits mirror those of a 1031 exchange, thereby allowing the investor to avoid the capital gains treatment on the profit and depreciation recapture.
Alternatively, there is the option of the real estate investor to take the cash at closing and pivot to other investments. Such investments include short-term rentals, multifamily properties, and syndication deals. All of these options are navigable in their own way. For example, pivoting to short-term rentals will likely yield higher returns but will require more maintenance and realize more wear and tear on your property. This may not matter if the investor leverages up into a higher valued property and utilizes the cost segregation depreciation to offset the capital gains and depreciation recapture. Speak with your CPA about crunching those numbers.
The point of this post is to provide this community with out-of-the-box thinking about taxes, depreciation recapture and to remind you all that at the end of the year, sales do not have to be as stressful as you might think. There are alternatives that will provide you with the benefits of real estate investing that you have enjoyed to date. As always, meet with your lawyer and CPA to discuss your options. There are always options.
Good luck out there!