Is Now the Time to do a 1031 Exchange? A look at the Delaware Statutory Trust

by Margaret Flowers

Are you holding onto an investment property and looking at the property values climbing? Have you considered if this is the time to sell the property? Do the taxes on the gain from the schedule have you sweating buckets? Have you considered the possibility of doing a 1031 exchange to cash in the gains and avoid the taxes on the gains, but realized that you would have to buy a new property?

If you have looked at possibly selling your existing investment property, you may have considered doing a tax-free exchange under section 1031 to avoid the tax on the large capital gains on the property (and the potential recapture of the depreciation you have claimed over the years). In researching the rules for the 1031 exchange, you may have come across the requirement to identify the replacement property within 45 days of the close date of the sale. In this real estate market, properties are selling quickly upon listing so to identify the replacement property and actually close on that property are getting extremely difficult. You can identify multiple properties to help protect your 1031 transaction, but once you identify more than three properties, there are rules about the market value of the identified properties exceeding the value of the property you want to sell. This can create a stressful environment or can be downright prohibitive from successfully executing a 1031 exchange.

Another issue to consider is if you are considering selling an investment property because you no longer want to be involved in the management of said property, you are looking to retire or reduce the amount of time spent on the property. In order to have a successful 1031 exchange you need a replacement investment property which will create the need to manage the property, thereby undermining your goals in selling your original property.

Enter the Delaware Statutory Trust (DST). Since 2004, the IRS has allowed investors to do a 1031 exchange from an investment property into a DST and continue to defer the gain. The Delaware Statutory Trust is a fractional ownership in an packaged investment of real estate properties. The Companies that offer these have several options depending on your desired investment term and investment goals. The properties generally are managed by the companies offering the investment so you can step back into a more passive role while maintaining the integrity of the 1031 transaction and maintaining cash flow from the properties. Because the packages are generally established, the identification requirement of the replacement property is able to be done quickly so that you can meet the rules required under section 1031.

If you have been debating doing a 1031 exchange but thought that the market forces currently at play were prohibiting you from successfully completing a 1031 transaction, you may want to consider looking into the Delaware Statutory Trust. You will want to consult your tax professional to see what the implications of doing so are and how much the tax savings would be to see if this is something you should consider.

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