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Benefits & Drawbacks

Potential Benefits/Drawbacks of Using 1031 DST Exchanges


1031 Individual Active Property to Property Exchanges

While both 1031 Exchanges offer the same general capital gains tax deferral benefits and abide by the same regulations under Internal Revenue Code 1031, there are some specific differences in the structure of these two types of 1031 Exchanges. 

Both are investments in real estate and subject to market value and rental income fluctuations, vacancies, tenant issues and government regulations. There are costs and fees associated with all 1031 Exchanges and the tax benefits must be weighed against the costs of the transaction. Each investor should consult their attorney and tax advisor before a decision is made.

Potential Benefits of a 1031 DST Exchange

Potential Benefits of a 1031 DST Exchange

1. Good-bye being a landlord. Being a landlord can be time consuming and stressful. Not having those concerns could make your life easier.

2. Enhanced cash flow potential. Many clients have increased their monthly income - often tax advantaged - through professional managed institutional commercial properties.

3. Property diversification by geographic and property types. Owning fractional shares of institutional properties - varied by types and in different parts of the country - could bring a diversification aspect to your property holdings that is difficult to achieve in a “conventional” individual property to property exchange. You may also use more than one DST property investment further increasing diversification. 

4. Less time-line deadline stress. Many times, a 1031 Exchange investor finds meeting the 45-day identification period and the 180-day exchange period deadlines difficult to arrange. Because a DST Exchange can close very quickly (usually within 10 days to two weeks) the investor does not have to worry about the replacement property not closing on time and making the entire transaction a taxable event. 

5. Flexibility to Invest the amount you want with a low minimum investment. Many times, with a conventional 1031 Exchange you cannot find a replacement property with the same dollar value as the relinquished property. With a 1031 DST you can buy the exact amount for your exchange needs, usually with as little as a $100,000 minimum investment.

6. Eliminate "Boot." If you paid less for your replacement property than you received on the sale of your relinquished property - for example, you sell your property for $1,000,000 and the replacement property is purchased for $900,000 the $100,000 of difference is taxable "Boot." Because 1031 DST Exchanges have lower minimums ($100,000) than most worthwhile active investment properties, the remaining $100,000…called Boot, can be used to purchase fractional shares of a current DST property as the replacement property in the 1031 Exchange and now all the capital gains remains tax deferred.

7. Lower liability. The DST is the sole owner of the property-each investor has a "beneficial interest" in the trust. This means you do not have a deeded title, nor any personal liability for the property. Also, you do not have to provide personal documentation for loan approval, personal assets or liabilities affecting the status of the loan as you would in a conventual 1031 Exchange. This is a non-recourse loan with no mezzanine or bridge financing to be repaid, reducing the overall expenses.

8. Potential stream of income. DSTs are allowed to keep on hand a reasonable amount of cash reserves in the event the property requires unexpected expenses. However, all earnings above the "held back" reserve amount must be distributed to the fractional owners (you) in the form of a monthly "mail-box check" or bank direct deposit.

9. Pre-Arranged Financing. There could be ongoing challenges for 1031 investors obtaining favorable financing for an individual property to property exchange. With a 1031 DST the national institutional sponsor removes that stress by pre-arranging the most favorable loan terms available. The lender only needs to make one loan because the DST owns 100% of the real estate… not "you" the investor. 

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Potential Drawbacks of a 1031 DST Exchange

Potential Drawbacks of a 1031 DST Exchange

1. 1031 DST investors give up control. Some investors want and need to have complete property management control. With a 1031 DST you give up that control and let a national institutional property manager do all of the landlord duties. Also, you have no say on the property sale time-line.

2. The 1031 DST properties are illiquid. Anyone purchasing a 1031 DST must assume that their investment is not liquid. This is a long-term investment with an average holding period, before sale, of often five to ten years. There is no secondary or public market available for the investor to sell their fractional interest in the DST. 

3. Costs, fees and charges. While different exchange types have similar exchange costs for the Qualified Intermediary (QI), attorney, tax advisor etc., a DST is a private placement security that is purchased through a FINRA Registered Representative, who is paid a commission on the sale of this investment. Please read and review the Private Placement Memorandum (PPM) to see what the objectives, risks, costs and other liabilities the buyer will undertake.

4. You must be an accredited investor. With a 1031 DST you must qualify as an accredited investor-an individual having income that exceeds $200,000 singly (or $300,000 with spouse) in each of the last two years, with reasonable expectations of the same income in the current year… or has a net worth of over $1,000,000 alone or with spouse (excluding the equity of that person's primary residence). These thresholds do not apply for a conventual property to property 1031 Exchange.

5. You cannot raise new capital in a 1031 DST. Once the DST offering is closed, there can be no future contributions to the DST by any current or new investor. The "reserve fund" can help with less major unexpected expenses when they occur.

6. Small offering size. Because many DST offerings are smaller in nature $10-$75 million-they have a tendency to fully subscribe and close quickly. DST offerings can stay open a few days or months depending on the capital raise.

7. DSTs must adhere to strict prohibitions. Known as the "Seven Deadly Sins" the 1031 DST must strictly adhere to. Our national sponsors, we partner with, have thoroughly met these prohibitions for you… the seven are as follows:

  1. Once the offering is closed, there can be no further capital contributions to the DST by either new investors or existing.
  2. The DST can't renegotiate existing loans or borrow more funds.
  3. The DST can't reinvest proceeds from the sale of its real estate.
  4. The DST is limited to making minor, nonstructural capital improvements, in addition to those required by law.
  5. Any cash reserves held between income distribution dates can only be invested in short term debt obligations.
  6. All cash and other reserves must be paid out to investors.
  7. The DST can't renegotiate existing leases or enter into new leases.
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This type of investment is subject to risks, including those real estate risks associated with the operation and leasing of retail properties. These investments are for Accredited Investors only. There can be no assurance the investment objectives will be achieved.

This material is neither an offer to sell nor the solicitation of an offer to buy any security, which can be made only by the Private Placement Memorandum (PPM), filed or registered with appropriate state and federal regulatory agencies, and sold only by broker/dealers authorized to do so.

Securities offered through Calton & Associates, Inc. 2701 N. Rocky Point Dr., Suite 1000, Tampa FL 33607 (813) 264-0440. 1031 Property Xchange and Calton & Associates, Inc. are separate entities.