Tactic To Avoid Cap-Gains Tax On Investment Property


Delaware statutory trusts -- structures through which investors can do like-kind exchanges to shield gains on investment property sales from tax -- are rising in popularity.

That is good news for property investors who are retired, approaching retirement and others who like to use DSTs, as they are known.

DSTs' rising usage reflects the recovery in real estate prices.

"The more that property rises in value, the more likely investors are to sell," said Brandon Balkman, vice president of marketing of OMNI Real Estate Services, which gathers data about 1031 exchanges, another name for like-kind exchanges. And when they sell at a profit, many want to roll those gains into another property rather than pay tax on the gain. DSTs help them do that."

Avoiding Tax

A primary use of a DST is to conduct a like-kind exchange. A like-kind exchange lets an investor avoid liability for capital gains on the sale of investment property.

The participant in the exchange invests in another investment property that costs at least as much as his proceeds from the sale of the first property. His principal residence does not qualify.

The investor must identify replacement properties within 45 days of selling the first property. And he must invest in the replacement property within 180 days of selling the first one.

Proceeds from the first sale must be held by a neutral intermediary until their reinvestment.

All Together Now

Like-kind exchanges can be done by individuals. A DST lets a number of investors band together to own investment real estate, which any one of them might not be able to afford individually, usually to do a like-kind exchange.

DSTs are rising in popularity as a replacement for tenant-in-common groups, another type of like-kind, multi-investor structure.

The key drawback to TICs, as they're known, is that lenders have to deal with all the participants.

"In contrast, a DST is a single entity controlled by a sponsor, so lenders know who they're talking and dealing with," said DST-specialist attorney Amy Giannamore of the law firm DLA Piper.

A sponsor is the person or group that organizes the DST.

A drawback to a DST is investor loss of direct control of a property.

The IRS first let DSTs be used in like-kind exchanges in 2004. The 2008-09 downturn made financing scarce, pushing investors to find a structure that lenders were comfortable with, Balkman says.

In 2013, investors used 40 DSTs and only five TICs, Balkman says. In 2006, 341 TICs represented $3.7 billion in deals. Regional broker-dealers such as Centaurus Financial and Berthel Fisher offer DST deals, says Louis Rogers, CEO of Capital Square Realty Advisors.

Retirees use DSTs to swap an investment property in a cold-weather location for another in their warmer retirement locale, or to rid themselves of a property that requires hands-on management that they no longer wish to perform.

DSTs often charge upfront loads as high as nearly 10%, Rogers says. Yearly costs tend to be 1% for commercial properties and up to 4% for multifamily ones.

Predictable Income

A key appeal of a DST is that commercial properties typically sign tenants to seven- to 10-year leases. Going into a deal, investors know what their monthly income will be.

"Getting that stated return 99% of the time is very attractive in a period of low interest rates," Rogers said.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

This article appears in: Investing , Mutual Funds

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