Investors have turned to a 1031 exchange for a solution on avoiding to pay capital gain taxes immediately. Not only does it allow investors to minimize immediate costs through tax deferrals, but it also gives us the opportunity to earn a higher return on investment by allowing us to find our own replacement properties. There are a variety of replacement properties we can choose from and it can be up to us, together with a qualified intermediary, to navigate and evaluate which can best maximize our profitability. Moreover, through the 1031 exchange DST investments, investors can diversify their portfolio with minimal risks as they are protected from liabilities and real estate properties have been known to increase in value as years pass.
However, 1031 exchange investments have different requirements and steps to follow. These can consist of complicated tasks wherein you may require help from intermediaries and firms other than the required qualified intermediary.
One of the steps in completing a successful 1031 exchange is identifying replacement properties. This must be done within the 45 days after the sale of the original property has been made. In identifying properties qualified as a replacement, here are three ID rules to choose from:
This is the least known and least common rule followed by exchangers. It allows you to identify and present many properties as you would like regardless of value. Exchanges just have to make sure they acquire 95% of the value of the identified property.
The exchanger can enumerate as many possible properties he /she may like, as long as the total does not exceed 200% of the original or relinquished property of an exchanger.
Three Property Rule
This rule is the most commonly used rule in choosing a replacement property. Only one to three properties are allowed to be identified by the exchanger regardless of the values of the properties.
Also, as you invest in a Delaware Statutory Trust, you become a trustee who must follow these rules or the “Seven Deadly Sins of DST”:
- There is a strict policy on offerings. Once it is closed, you can no longer contribute equity to the Delaware Statutory of Trust. Current or new co-investors and beneficiaries are bound by this rule.
- Trustees of the Delaware Statutory of Trust are not allowed to borrow any new funds from lending firms or parties and also renegotiate matters on existing loans.
- Proceeds from the sale of investment real estate properties are not allowed to be reinvested by a trustee.
- There are limits where trustees can only make capital expenditures. These are simply on repairs, maintenance, and minor capital improvements that are non-structural. Also, the law may require expenditures to be made, and this is one of the few capabilities of an individual as a trustee.
- Liquid cash held between distribution dates can be allocated to investing in short-term debt obligations.
- With exception to necessary reserves, it is a must to distribute all cash to beneficiaries or co-investors on a current basis.
- Lastly, it is important not to forget that trustees cannot renegotiate present leases or enter into new ones.