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1031 Exchange Rules

1031 Exchange Rules For A Delaware Statutory Trust 

1031 Exchange Rules - Using a 1031 DST Can Help Defer Capital Gains Taxes 

Benjamin Franklin coined many sayings we still use today, but the most often quoted is probably, “In this world nothing can be said to be certain, except death and taxes.” And while it is nearly impossible to totally avoid every tax, tax-efficient advisors can help their clients minimize them and when they can’t be avoided, deferred for as long as possible. I’m going to share with you one way of accomplishing that goal with a 1031 exchange DST. But there are many 1031 Exchange Rules that you must follow, and we will help explain these for you. 

Revisions to the tax code under The Tax Cut and Jobs Act, which went into effect in January 2018, eliminated many of the deductions such as for charitable contributions or state and local taxes that taxpayers traditionally relied upon. Fortunately there are still ways to lower your current tax bill, including using a 1031 Property Exchange. Even with moderate rates of return, many high-income real estate investors have found this vehicle to be an effective way to grow their wealth because they can re-invest their profits over and over, while continuing to keep the tax man at bay. But there are many 1031 Exchange Rules that you must abide by in order for the 1031 exchange to effectively work. 

Often real estate investors are unaware that while the value of their properties has appreciated considerably over the years, when sold those capital gains are taxable at the rate of 15% or 20%, depending on the individual’s taxable income. But by deferring those taxes and putting the proceeds into a 1031 vehicle many investors find that they can generate monthly distributions probably at the same rate they would be getting from those rental properties without having to deal with the management themselves or paying a management company. In order to defer the capital gains tax, there are many 1031 Exchange Rules that you must follow in order to comply with the IRS in 2019. 

1031 Exchange Rules When Deferring Capital Gains Tax

In many ways real estate remains a protected asset class, and long-term real estate investors can defer capital gains taxes on their appreciated investments indefinitely, by using a Delaware Statutory Trust as part of a 1031 property exchange (1031 DST). Under the 1031 Exchange Rules the DST can help defer the capital gains tax in 2019. 

When an investor puts the proceeds from the sale of a property into a 1031 DST, they are making a one-time investment in a specific property or group of properties, along with a group of other investors, each of whom owns a prorated percentage of the trust. This process helps defer the capital gains tax that you incurred on your property as long as comply with the 1031 Exchange Rules

1031 Exchange Rules 2019 For Property Owners

There are two types of investors for whom a 1031 DST can be especially beneficial—those who for various reasons no longer wish to manage their properties themselves, and those who invest in real estate do so because it provides a steady income stream but have no interest in managing their rental properties themselves. In either case, hiring a management company to collect the rent and handle maintenance is a possible solution, but it comes at a cost which can greatly reduce the net profit returned to the investor.

Rather than paying a management company, using a 1031 DST allows investors to reap the benefits of from their property’s appreciated value by selling it, applying the proceeds to the purchase of part of a new property and continuing to defer taxes on their capital gains. But with none of the headaches that come along with being a landlord.

To show how a 1031 DST can work, let me cite the example of a couple I’ve worked with here in southern California. They had a rental property that they bought in 1980s for $80,000 and had always handled management and maintenance themselves. As they got older and their health declined that became a burden they no longer cared to deal with. Since, like much real estate in the region the value of the property had grown considerably and they were able to sell it for $500,000. That meant that if they didn’t re-invest their profit into something tax-sheltered that even after deducting what they’d spent on the property over the years they would be subject to huge taxes on their capital gains in 2019.

They like being property owners and didn’t want to reduce their own income stream by keeping the building and paying a management company. I suggested to them that the right 1031 DST could give them a similar return to what they had been realizing without having to either manage the property themselves or hiring a professional manager.

The benefit for these clients of making this strategic move is that they have deferred that taxes on their appreciated real estate assets, while retaining a steady income stream in 2019 while following the 1031 exchange rules

This strategic move can provide considerable tax advantages while still providing a steady income stream and allowing the individual to retain appreciable assets. One of the problems facing long-term real estate investors is that long-held properties that have appreciated considerably over the years are likely to have large capital gains. The new tax law did not affect capital gains which are taxable at the rate of 15% or 20%, depending on the individual’s taxable income. So deferring those taxes and putting the proceeds into a 1031 vehicle that can generate those monthly distributions at around the same rate they would be getting from their rental properties without having to deal with the management themselves or paying a management company. If you follow the 1031 exchange rules and get into a DST, you can avoid paying a management company for your property.  

1031 Exchange Rules - Identification Options 

There are a number of reasons why I think a 1031 exchange DST is preferable for many clients over a traditional 1031 exchange, primarily that a 1031 DST can be executed faster and much with fewer complications within the rules. With a 1031 DST the turnaround time can be as little as 24 to 72 hours. With a traditional 1031, the investors has 45 days to identify a property, if they do identify a property they have 180 days to close and if they don’t close in 180 days, then they lose out on the 1031 and are subject to the tax. The IRS has a lot of 1031 exchange rules on a traditional 1031 that make it more difficult to do, but a DST is fairly simple. Because there are a lot of stringent 1031 exchange rules, we suggest going into the DST as a way to defer the capital gains tax, but still retain the monthly income.  

One final point about the 1031 DST is that if the property is held until death, and becomes part of individual’s estate that gains may end up being tax free altogether if the estate comes in under the new threshold for estate taxes. In which case Benjamin Franklin’s famous maxim is only half true.

Learn More Of The 1031 Exchange Rules By Contacting Us

If you’d like to learn more about how a 1031 DST can help you defer capital gains taxes, or understand some of the 1031 exchange rules, give us a call at 805-583-2720 or email kyle@winthco.com. 

 

 

 

 

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