2022 tax documents will be available for download by Jan. 31, 2023.

About Section 1031 Exchanges & Delaware Statutory Trusts

Section 1031
  • Commonly referred to as a “like-kind exchange.”
  • Allows for the complete deferral of all federal and state taxes on relinquished property.
  • Seller of a relinquished property must reinvest sale proceeds into a like-kind property.
  • Can exchange any type of real estate for any other type of real estate (personal property does not qualify).

The gain that would have been recognized in a taxable sale is deferred until the replacement property is sold in a taxable transaction. In most deferred exchanges, taxpayers engage a “qualified intermediary” to prepare an exchange agreement and hold the net sales proceeds from the relinquished property in an exchange escrow account pending acquisition of the replacement property. Taxpayers may structure a series of exchanges, compounding the benefits of tax deferral, thereby building wealth over time.

The taxpayer may exchange real property for any other real property located in the United States or its possessions for productive use in a trade or business or for investment.

  • “Like-kind” refers to the nature or character of the property and not its grade or quality.
  • Generally, all real property is “like-kind” to all other real property.
  • Real estate and personal property are not like-kind.
  • Real property can be improved or unimproved (land), which means taxpayers may exchange unimproved real estate for improved real estate and vice versa.
  • The exchanger’s intent must be to hold the replacement property for investment or use in a trade or business.
  • DEBT - Debt secured by relinquished property must be offset by equal or greater debt secured by replacement property (reduction of debt may be offset by cash from another source).
  • TAXABLE BOOT - Any cash or non-like kind property received in the exchange is taxable.

All days are calendar days, regardless of whether the day falls on a holiday or weekend.

Day 1

SALE OF RELINQUISHED PROPERTY

Day 45

SALE OF RELINQUISHED PROPERTY

Replacement property must be identified in writing within 45 days. Multiple properties may be identified.

Day 180

CLOSING DEADLINE

All replacement property must be acquired by earlier of 180 days or the due date of taxpayer’s tax return.

Taxpayers may structure a series of exchanges to compound the benefits of tax deferral, thereby potentially building wealth over time.

  • Defer federal and state taxes (does not forgive taxes; tax will be paid if later sold in a taxable transaction).
  • Build family wealth over time with multiple exchanges.
  • Exchange non-income producing property (for example, land) for income-producing property (for example, multifamily).
  • Exchange actively managed property (rental house) for passive property (DST).
  • Acquire higher quality replacement property than a taxpayer can afford on their own.
  • Diversify to reduce risk by acquiring several replacement properties.
  • Potential tax forgiveness for heirs with a step-up in basis upon death.

A Delaware statutory trust (DST) is a private real estate investment vehicle that allows investors to participate in a Section 1031 exchange and receive passive income as well as potential for appreciation from real estate ownership. This equation provides the potential for superior risk-adjusted returns.

The DST owns 100% of the real estate.

  • Investors have no personal liability. Annual LLC fees are also eliminated for investors.
  • Investors do not provide tax returns to lenders or sign loan documents – lender does not underwrite the investors; the sponsor signs carve-out
  • Investors have protection against any recalcitrant investors.

Lower investment minimums per participant.

A simple and efficient investment process with access for more investors.

The sponsor is in charge of managing the property and makes decisions when necessary.

A Delaware statutory trust (DST) is a distinct legal entity created as a trust under the statutory law of Delaware. In a DST, each owner is treated as owning an undivided interest in the real estate for tax purposes. Capital Square’s DST offerings comply with the requirements of IRS Revenue Ruling 2004-86. This means that each owner’s beneficial interest is treated as a direct interest in real estate for tax purposes.

The DST structure has proven to be superior to other fractionalized ownership structures. Lenders view the trust as a single borrower rather than having up to 35 individual borrowers in a tenant-in-common, or TIC, structure. DST programs qualify for favorable financing from conduit lenders, banks, life insurance companies and government agencies. In addition, because investors are not on title in a DST structure, investors need not form special purpose entities to hold their ownership and lenders look solely to the DST sponsor for any liability on loans. This means that DST investors have no personal liability whatsoever on DST loans.

Asset Protection – Limits rights of creditors (creditors of a DST investor cannot attach trust assets).
Liability Protection – DST investors of the trust have the same liability protections that Delaware law provides to stockholders of a Delaware corporation (generally, no personal liability).
Confidentiality – Provides privacy for the beneficial owners.
Contractual Flexibility – Provides maximum contractual flexibility.

DSTs provide a number of benefits to investors, including:

  • Tax deferral
  • Portfolio diversification
  • Passive income
  • Access to higher quality real estate
  • Liability protection
  • Debt replacement required by Section 1031
  • Potential tax forgiveness to heirs (step up in basis on death)
  • Ability to shelter distributions through the use of depreciation deductions plus bonus depreciation and cost segregation

To qualify for a DST, trustees may not:

  • Accept capital contributions after the offering is closed
  • Renegotiate existing loan terms or borrow new funds
  • Sell real estate and use the proceeds to obtain new real estate
  • Invest cash between distribution dates other than in short-term government debt
  • Make more than minor repairs considered either normal repair and maintenance, minor non-structural improvements or repairs required by law
  • Retain cash other than necessary reserves
  • Enter new leases or renegotiate the current lease (unless permitted under a master lease)

Simple Process and reasonable filing fees:

  • A certificate of trust is filed with the Office of the Secretary of State of Delaware.
  • A trust agreement is prepared but is not filed with the State of Delaware.
  • There are no annual fees in Delaware, not subject to Delaware’s franchise tax.

Flexible tax treatment:

  • A DST can be taxed as a corporation, partnership, trust, or disregarded entity for 1031 programs (see Rev. Rul. 2004-86).
DST
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Preservation of Capital

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Buy Stable Assets for Cash Flow

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Diversify to Reduce Risk

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Add Value- When Appropriate

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Trust but Verify with Property Audit

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Patient, Long – Term Thinking

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Think Outside the Box

Sometimes referred to as an accommodator, a qualified intermediary facilitates Internal Revenue Code Section 1031 exchanges. Treasury Regulation §1031.1031(k)-1(g)(4)(iii) defines a qualified intermediary as a person who:

  • is not the taxpayer or a disqualified person; and
  • enters into a written agreement with the taxpayer (the “exchange agreement”) and, as required by the exchange agreement, acquires the relinquished property from the taxpayer, transfers the relinquished property, acquires the replacement property, and transfers the replacement property to the taxpayer.

Taxpayers can avoid actual or constructive receipt of the proceeds of sales by using a qualified intermediary and following the regulatory safe harbor. A qualified intermediary cannot be related to the taxpayer or have a financial relationship with the taxpayer within two years of closing on the exchange.

Contact us now to get connected with a qualified intermediary.

    Benefits of
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    INCOME – Real estate investments generate income from rent paid by tenants.

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    INFLATION HEDGE – Real estate has served as an effective hedge against inflation, as lease rates and underlying property values typically keep pace with (or exceed) the rate of inflation. Capital Square targets properties with long-term leases that have built-in rent escalations to compensate investors for future inflation.

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    TAX BENEFITS – Section 1031 permits gains to be deferred on the sale of investment/business property. Additionally, real estate provides material tax benefits unavailable for other investments.

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    APPRECIATION – Real estate typically appreciates over time, resulting in gains that can be deferred in future exchanges or realized upon sale.

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    DEPRECIATION DEDUCTIONS – Real estate provides material tax benefits, such as depreciation deductions, that are not available with other investments. In fact, depreciation is one of the most compelling benefits to real estate investors because depreciation is a non-cash deduction (in other words, you don’t pay for it). Real estate owners are allowed to reduce their taxable income by a deduction for depreciation (the theoretical wear and tear on a property, even though properties tend to appreciate in value over time). This is a non-cash deduction – real estate owners pay nothing for the benefit, which can provide greater overall return of their investment by sheltering from taxation otherwise taxable income.

    Contact us now to learn more about our turn-key real estate investments.

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