Client Case Study – The DST Parachute Saves a 1031 Exchange

For many real estate operators, investors, and owners, their real estate is much more than just property. Whether they own a single commercial building, a portfolio of commercial properties, or a collection of residential rentals, that real estate has meaning beyond NOI (Net Operating Income), occupancy, and FMV (Fair Market Value). Those properties are the culmination of a life’s hard work, the entirety of their worldly wealth, or their nest egg to help see them through their golden years.

For these reasons, a botched 1031 exchange can be devastating. Clients with highly appreciated and/or highly depreciated properties may be at the risk of debilitating tax bills. Between a possible capital gains tax at 20%, potential depreciation recapture tax at 25%, and an additional Net Investment Income tax at 3.8% (sometimes called the ObamaCare tax), a failed exchange and an unexpected tax bill can take a sizable chunk out of that nest egg, erasing years of hard work and wealth accumulation.

The 1031 Exchange

A client of Fortitude Investment Group recently had himself a very good day. He received a large offer on his commercial property. This property made up the majority of his worldly wealth and represented years of hard work. As an owner/operator nearing retirement age, he used this as an opportunity to Identify a replacement property in his desired retirement city. He sold his house and he and his wife moved to his new city, even before closing on his replacement property and completing his exchange.

The Fallback Plan

During the strict 45-day identification period, we helped the client determine which Delaware Statutory Trust’s (DST’s) most closely met his investment criteria. We also helped determine which DST’s might remain available long enough to be used as the replacement property if his preferred property did not make it to closing (as a “back-up”). This can happen for any number of reasons – financing problems, due diligence findings, tenants’ Right of Refusal, etc. We were able to use the 200% rule to identify both the DST’s and his preferred whole property.

The Result

Unfortunately, factors uncovered during the due diligence process, but after the close of his 45-day ID period, made the purchase and operation of the client’s first choice property untenable. However, because he had also identified DST’s as a fallback option, he was able to successfully complete his exchange and defer what could have been a large tax bill. By closing on his identified DST’s, he was afforded the potential for passive income and appreciation through fractional ownership of institutional real estate assets. These investments were also diversified geographically and by real estate sector.

The use of the DST, along with assistance from the Fortitude team, resulted in a completed exchange and help circumvent what may have otherwise been a hefty tax bill. The client’s relinquished property was both fully depreciated and highly appreciated, meaning that he would have owed upwards of 20% of the FMV of the property to Uncle Sam. With most of his net worth tied into this property, a payment of that sort would have significantly impacted his retirement income and his subsequent quality of life.

If you or your clients need more information about 1031 exchanges, please contact our team or visit our website!

This is for informational purposes only and is not an offer to buy/sell an investment. Examples are for illustration purpose only – individual circumstances may vary. There are material risks associated with investing in DST properties and real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal.  Diversification does not guarantee profits or guarantee protection against losses. Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated. DST 1031 properties are only available to accredited investors (typically have a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last three years) and accredited entities only. If you are unsure if you are an accredited investor and/or an accredited entity please verify with your CPA and Attorney. Because investors' situations and objectives vary this information is not intended to indicate suitability for any particular investor. Fortitude Investment Group does not offer tax or legal advice. Please speak with your legal and tax advisors for guidance regarding your particular situation.

Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Advisory services offered through Concorde Asset Management, LLC (CAM), an SEC registered investment adviser. Insurance products offered through Concorde Insurance Agency, Inc. (CIA) Fortitude Investment Group is independent of CIS, CAM, and CIA.