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Delaware Statutory Trust Case Studies

Case Study #1 – A call came in from a local CPA explaining how they had a client that was going to close on a sale of a property in the near future and would have to pay substantial capital gains tax as well as depreciation recapture. The question was simple, was there any way other than a direct property to property 1031 exchange that could save the client taxes. The capital gains and depreciation recapture taxes would be substantial since the property had appreciated significantly and the client had taken every opportunity to fully depreciate.

The CPA further indicated that the client had another property in mind that might serve as a good 1031 opportunity but they weren’t sure if they would be able to close on the new property in time to meet the 1031 guidelines. In fact, they weren’t even sure if they would be able to close the deal at all. The CPA had heard that there was a way to hedge against the possibility of a substantial tax by identifying a qualifying DST at the time of settlement and up to 45 days after settlement. If there was a way to reduce this tax uncertainty, they wanted to present this to their client. The DST would serve as a backup property in case the replacement property deal fell through which of course would give their client an alternative tax savings strategy.

Case Study #2 – A call came in from a local estate planning attorney asking if there was a way to sell real estate and roll the proceeds into something other than another real property while still deferring taxes. The attorney represented an older couple that had built a substantial fortune in commercial real estate properties. The couple wanted to start liquidating the properties because they no longer wanted to deal with the issues associated with being a landlord and because they wanted to leave a simplified, securitized and unitized asset portfolio for their children and their other beneficiaries. The attorney had heard about DSTs, but wasn’t sure how they worked and what the benefit would be. He thought that perhaps it would be better to sell the real estate, pay the taxes and invest elsewhere as he had recommended in the past, but if DSTs were a better solution he would explore them with his client.

Once again, the impetus was that his client had reached a point in life where they no longer wanted the responsibility of dealing with the four T’s-Tenants, Trash, Toilets and Termites. They simply wanted a check to arrive on a monthly basis and secondly, they did not want their children to have to deal with real estate issues after their death since their children had no interest. The couple understood that real property would present real headaches to their children and might be a source of contention. They wanted to avoid potential disharmony and allow each of their beneficiaries to do what they wanted with their share of their inheritance. By selling the real property and investing instead in a DST, they would essentially transform a tangible, illiquid, “hands-on” real property into a passive, “unitized” security that would give them more flexibility for gifting and estate planning.

The sale of the property and the 1031 exchange into a DST was a solution they explored. They particularly liked the fact that it would be invested in institutional quality real estate under professional management and that it would receive the stepped-up cost basis upon their death just like the original properties would have received. This while paying no current taxes.

Case Study #3 – A call came in from a local developer that was having a hard time persuading a farmer to sell them a developable property because the farmer would have to pay substantial taxes and wanted the developer to pay for his tax liability in order to sell. The developer wanted to know if there was a way to persuade the farmer into selling so that everyone could win? Once again, the farmer would be able to roll the proceeds to a DST and defer paying the taxes until such time as they chose and if they chose to keep rolling one DST over into another they could essentially avoid taxes indefinitely. The farmer was able to convert farmland into income producing real estate and the developer was able to buy the land for a cheaper price than if taxes would have to be paid.

Case Study #4 – An urgent call comes in from a commercial real estate agent because one of his clients is closing in on the 45-day window and the replacement property deal doesn’t look like it is going to become a reality. Is there anything that can be done. The answer is yes. We identify two DSTs as replacement properties and see what happens. At the last hour as is often the case in these matters, the deal goes through but there is still a problem. If the deal had not worked out, 100% of the money could go into the DST solution and taxes would be avoided, but in this case, the replacement property was eventually purchased for less than the relinquished property. There was still a good chunk of taxes that would be due. Fortunately, the difference in price can be invested in a DST or series of DSTs in order to avoid current taxes. This particular commercial real estate agent has made it a habit to always include or identify a backup DST every time they look to do a 1031 exchange. It’s tax insurance and attracts more clients.

Case Study #5 – A call comes in from a business broker that specializes in succession planning. Her client is selling a business and isn’t sure if she wants to leave it to her son or sell it outright. A substantial portion of the value of the business is associated with appreciated real estate and the real estate is owned outside of the business. Her client insists on selling the real estate if the business ends up outside of the family because they do not want to assume tenant risk. Furthermore, her client recognizes that they can structure the transaction to their tax benefit if they have some flexibility in terms of the allocation of the sales price between the real estate and the remaining value of the business. The DST provides this flexibility if the sale goes through to the outside party.

Sera Capital Management – we are registered investment advisors and as such we do not accept commissions. Because DSTs are securities and only available to accredited investors, the selling agent must have a securities license. Our firm has developed a consulting practice in the DST arena and our fees are up front, transparent and we only get paid if the transaction successfully goes through. When the transaction closes, we waive 100% of the commission that would normally go to the selling agent. This means that our clients can save substantial fees and own a higher beneficial interest. As fiduciaries we have no incentive to steer our clients into a higher commission vehicle. Because we are transparent and only work with the top DST sponsors in the country, we believe our value proposition is attractive to our clients. They see everything up front and recognize we sit on the same side of the table with them.

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Delaware Statutory Trusts Can Help Clients

• Defer long term capital gains and depreciation recapture
• Receive tax-advantaged income
• Provide heirs with a stepped-up cost basis
• Assist in estate planning
• Unwind real estate positions
• Ensure that real estate transactions close in the 45-day identification period
• Match debt and equity
• Solve the “boot” problem, when relinquished property costs more than the replacement property
• Acquire vacant farmland or real estate for development
• Sell their businesses when properties and land are part of the conditions of sale

And as always, with many DSTs, broker/dealer commissions are baked into the cost of each deal. When considering DSTs, it’s important to work with an investment fiduciary who will waive these commissions and work on a consulting basis, that way, clients receive more beneficial interest in each DST.

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Why Brokers Recommend DSTs to Their 1031 Exchange Clients

 

1. DSTs Make Great Back Up Properties You’ve sold a property and you’ve identified a replacement property. Unfortunately, for a variety of reasons, the replacement property can’t settle under the 1031 timeframe guidelines. If/When this happens, your client can still avoid taxes if you have identified a back-up property. A back-up property gives your clients the greatest chance of a successfully executed 1031 exchange. How does it work?

1) You identify the primary replacement property and 2) You identify one or two additional properties owned by DSTs. It costs no extra money to identify additional properties. Taking this precaution insures that you and your client have adequate choices.

2. Avoid Taxable Gains on Boot Matching the exact dollar amount of a replacement property is almost impossible in 1031 transactions. But the intelligent use of DSTs as Boot can help solve the matching problem. For example, if the relinquished property sells for $2.0 million and the replacement property for $1.8 million you have a mismatch. The $200,000 difference is taxable. However, if you have identified a DST as a back-up property you can invest the $200,000 in the identified DST and save your client taxes.

Sale Price of Relinquished Property: $2.0 million
Replacement Property #1: $1.8 million property identified by investor/broker
Replacement Property #2: $200,000 investment in property owned by DST

3. Don’t Get Sidelined Many brokers have clients that will not sell until they either find the “right” property or because they simply don’t want to pay capital gains taxes and depreciation recapture. Having the option to invest in institutional-grade properties owned by professionally managed DSTs may get investors off the sidelines.
This is especially true for clients looking to unwind or reduce their real estate holdings and don’t want to continue purchasing real estate. DSTs allow your clients to defer taxes on their real estate sales, collect tax-advantaged income and receive a stepped-up cost basis in their estate planning. For brokers, one sale is better than no sale.
Sera Capital, A Registered Investment Advisor, has relationships with the industry leaders in offering replacement properties, typically through a Delaware Statutory Trust (DST), for Section 1031 exchange transactions, as well as quality, real estate financing solutions.

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10 Reasons To Consider DSTs

Avoid Financing Obstacles

In a 1031 exchange transaction, the debt placed or assumed on the replacement property must be equal to or greater than the debt relieved in the relinquished property. Property owners may run into a road block when they try to get financing on their replacement properties. For example, a property owner may wish to sell an apartment building worth $5 million with $2.5 million in debt, or 50% loan-to-value (LTV). If that property owner cannot get approved for a $2.5 million loan on their replacement property, then most likely the owner will not sell.

The majority of programs are structured so that the replacement property is owned by a Delaware Statutory Trust, or DST. The DST is a pass-through entity that owns the real estate assets. When a replacement property is owned by a DST, the DST will be the borrower of any loan and investors in that DST will not need to be individually qualified with a lender.

DSTs Make Great Back Up Properties

A common strategy to identify replacement properties is the “3 Property Rule,” where an exchanger may identify up to three properties, without regard to their fair market value, within 45 days. Identifying only one property may be dangerous because a property can fall out of escrow for many reasons: financing, inspections, etc.

To secure an opportunity to execute a successful 1031 exchange, the exchanger could identify the first property as defined by the investor/commercial real estate broker. The exchanger can then identify two additional properties owned by DSTs. It costs the exchanger no extra money to identify additional properties. Taking this precaution insures that the exchanger has adequate choices.

Property #1: Property identified by investor/broker
Property #2: Property owned by DST
Property #3: Property owned by DST

Avoid Taxable Gains on Boot

The exact dollar amount of the replacement property is a common challenge in 1031 transactions. In one example, the relinquished property sells for $2.0 million and the exchanger identifies a replacement property for $1.8 million. The difference in the price of the relinquished property and the price of the replacement property results in a  taxable amount on the remaining $200,000. Under the “3 Property Rule,” DSTs provide a solution:

Sale Price of Relinquished Property: $2.0 million

Replacement Property #1: $1.8 million property identified by investor/broker
Replacement Property #2: $100,000 investment in property owned by DST
Replacement Property #3: $100,000 investment in property owned by DST

No Property Management Headaches

Property is professionally managed by a third party in a DST-structured 1031 exchange. Professional managers handle the Terrible T’s: Tenants, Toilets, Trash, Turmoil, Termites. The investor enjoys the Terrific T’s: Travel, Time, Tennis. DST programs offer additional benefits, including the direct deposit of distributions, if any, and reporting through Substitute 1098/1099s.

Diversification Benefits

Investing in a DST can provide portfolio diversification. For instance, an investment could be made in a single DST that owns multiple properties in several states. It would be almost impossible for a broker to identify three replacement properties in three different states within the allowed 45-day timeframe. So DSTs are an optimal way to achieve diversification.

Don’t Get Sidelined

Many realtors have clients that will not sell until they find the “right” property. Having the option to invest in institutional-grade properties owned by professionally managed DSTs may get investors off the sidelines, and the realtor receives their commission.

Swap ‘Til You Drop

A DST is different than a 721 Exchange (UPREIT) transaction where the investor’s exchange journey ends with the sale of the UPREIT. The DST structure allows the investor to continue to exchange properties over and over again until the investor’s death. Upon the death of the investor, under current tax laws, the heirs would get a “step up” in basis, thereby avoiding capital gains taxes on the original and subsequent properties.

Estate Planning Tool

Everyone wants the best possible scenario for their heirs before they pass. Investing in a DST eliminates the opportunity for heirs to argue over what to do with an investment property when the owner passes away. The heirs continue to receive distributions from the investment, if any, and upon the sale of the property owned by the DST, each of the heirs can choose what to do with their inherited portion. One heir can continue to exchange the investment, while another can sell and receive cash proceeds.

Quality Properties and Leverage Options

DST Sponsors maintain a diversified portfolio of properties across the United States, and a wide variety of property types and leverage options. This wide range of opportunities enables investors to select a high-quality, institutional-grade private placement program that best suits their needs.

Low Minimums

An investor can exchange as little as $100,000 into a Sponsored DST. This can include the remaining assets leftover from a property exchange.

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Carl and Carlos Sera 3

Carl and Carlos Sera

Founded in 1990, Sera Capital is a private, independent, employee-owned investment manager.

“We are investors” helps explain the essence of our firm. This simple, singularly focused identity defines what attracts clients and inspires us to come to work every day and share in our mission–to partner with our clients to achieve their unique objectives. Our attention is entirely directed at managing client assets. Our fiduciary responsibilities are instilled in our employees and are reflected in our approach to client assets.

To learn more about who we are and what we do, visit financialtales.com.