1031/DST SOLUTIONS
DST SOLUTIONS
A 1031 Exchange DST is a vehicle used to defer capital gains tax from the sale of an investment real estate asset. DST’s offer the potential for monthly income and diversification.
If you’re tired of dealing with the daily responsibilities of actively managing real estate or you’re afraid of the huge tax burden coming after you sell your property, a DST might be just what you’re looking for. With a DST, investors can still enjoy the benefits of owning real estate without dealing with the tenants, toilets, trash, and potential tax liability.
Many investment properties qualify for the deferred tax investment. These include unimproved and improved properties, vacant land, net-lease property, commercial buildings, rental properties, farms or ranches, resort property, industrial property, office buildings, retail space, self-storage facilities, senior-living centers, hotels or motels, restaurants, daycare facilities, tire and automotive stores, and TIC properties.
A DST could serve as a backup plan in case a 1031 Exchange fails to meet the 45 day property identification requirement. This is a strict IRS imposed rule but fortunately DST’s are readily available, and most investors close within 3-5 days.
DST’s allow you to invest down to the penny, ensuring that 100% of your exchange funds are invested. You can choose the exact amount you wish to invest. Excess funds remaining from a 1031 Exchange transaction are referred to as boot. Boot is normally taxed but this can be avoided if these funds are invested in a DST. This allows you to diversify how the sale of your property is handled while maintaining tax-deferred status.
Deferring taxes results in a larger investable amount which can have a compounding effect over time. Here is an example to show the benefits of utilizing a DST versus investing after tax dollars:
TAX DEFERRAL BENEFITS
Assume you purchased an apartment complex in Colorado for $2,500,000; investing $1,000,000 of your own money and financing $1,500,000 with a loan.
INVESTORS CASH EQUITY $1,000,000
LOAN FINANCING $1,500,000
TOTAL PURCHASE PRICE $2,500,000
After several years you decide to sell the property for $5,000,000 with a total capital gain of $2,500,000. Your adjusted tax basis will be approximately:
TOTAL PURCHASE PRICE $2,500,000
PLUS: ACQUISITION COSTS $20,000
(fees required to obtain a property)
PLUS: CAPITAL IMPROVEMENTS $90,000
(structural changes that enhances a property's value)
LESS: DEPRECIATION $(610,000)
LESS: DEFERRED CAPITAL GAINS $-
EQUALS: ADJUSTED TAX BASIS AT SALE $2,000,000
Calculation of Realized Gain assuming $60,000 in closing costs:
SALES PRICE OF RELINQUISHED PROPERTY $5,000,000
LESS: CLOSING COSTS $(60,000)
(on relinquished property)
EQUALS: NET SELLING PRICE $4,940,000
LESS: ADJUSTED TAX BASIS $(2,000,000)
EQUALS: REALIZED GAIN $2,940,000
If the loan has been paid down to $1,000,000. The cash received for the sale of the property will equal:
SALES PRICE $5,000,000
LESS: BALANCE ON LOAN TO PAY OFF $(1,000,000)
LESS: CLOSING COSTS $(60,000)
(on relinquished property)
EQUALS: NET CASH RECEIVED ON SALE $3,940,000
Your potential tax liability will be:
Tax Type Effective Tax Rate Tax Amount
FEDERAL 20% $466,000
(20% x realized gain minus depreciation)
STATE (CO) 4.63% $136,122
(4.63% x realized gain)
AFFORDABLE CARE ACT SURTAX 3.8% $88,540
(3.8% x realized gain minus depreciation)
DEPRECIATION RECAPTURE 25% $152,500
(Depreciation x 25%)
TOTAL CAPITAL GAIN TAXES $843,162
Benefits of a 1031 Exchange:
With Exchange Without Exchange
NET PROCEEDS FROM SALE $5,000,000 $5,000,000
LESS: TAXES PAID $0 $(843,162)
EQUALS: AVAILABLE EQUITY $4,940,000 $4,156,838
CASH RECEIVED $4,940,000 $3,096,838
This hypothetical example shows the major benefits of completing an exchange transaction. The money saved by avoiding taxation works harder for you when reinvested. The benefits of compounding help your investment grow further.
Equity Accumulation after 1031:
Exchange into DST Without Exchange
NET PROCEEDS FROM SALE $4,940,000 $3,096,838
ANNUAL ROI OF 5.5% $271,700 $170,326
5 YEAR - ROI $1,358,500 $851,630
5 YEAR APPRECIATION 20% $5,928,000 $3,716,206
The $3,096,838 was invested with after-tax dollars This resulted in total income of $851,630 after 5 years. The $3,096,838 investment grew to $3,716,206, resulting in an additional $619,368 of equity. The initial $3,096,838 grew to a total of $4,567,836 including income and equity.
The $4,940,000 that was invested into the DST avoided taxation. This resulted in total income of $1,358,500 after 5 years. In addition to the income, the $4,940,000 investment grew to $5,928,000, resulting in an additional $988,000 of equity. The initial $4,940,000 grew to a total of $7,286,500 including income and equity.