InSight

Pros, Cons, and Risks in a Delaware Statutory Trusts (DST)

Financial Planning Dentist

Delaware Statutory Trust Pros:

As an income source:

DSTs are popular with people in general who wish to develop some diversity in their investment portfolio by introducing some real estate components. People like being able to count on the specific return and appreciate not having to deal directly with tenants. They are also extremely popular with 1031 exchange investors for the same reasons but also due to the fact that it can be difficult to identify replacement property within 45 days of the sale of their relinquished property and they have certainty of closing within the applicable 180-day window. 

As a source for replacement debt (for 1031’s):

Most investors participating in a 1031 Exchange require the new investors to have a prorated portion of the debt to be able to replace the portion lost when relinquishing the property. The debt is non-recourse to the investor but allows the investor to hold new debt equal to or greater than the debt retired upon the sale of the relinquished property. A DST can make being assigned this debt an easy prospect. 

The transfer of the relinquished property to the Qualified Intermediary and the receipt of the replacement property from the Qualified Intermediary is considered an exchange. To be compliant with IRC Section 1031, the transaction must be structured appropriately, rather than being a sale to one party followed by a purchase from another party.

As a backup plan (for 1031’s):

Exchange investors also sometimes use a DST as a backup in case the primary identified property falls through or the primary property acquisition does utilize the entire exchange value. The DST purchase can absorb the balance.

Delaware Statutory Trust Cons:

Like any real estate investment, DSTs have traditional risks associated with them. Real estate risk, operator risk, interest rate risk, and liquidity risk are all common risks associated with the DST investments. The sponsor does due diligence as does the back office of the broker or adviser’s firm, but so should the investor. 

Asymmetrical Risk:

The prospectus typically does a good job of pointing out other risks of each such individual investment. But the location of the investment, the building type and local market, and the quality of the sponsor are all important non-idiosyncratic risks investors should be familiar with in DST investing. 

Real Estate Risk

While it is regulated and sold as a security, at its core, DSTs are real estate, and the risks of any real estate investment apply. Real estate risk in this context is exactly equivalent to the real estate you presently own, including your own home. The local market can drop, the economy can decline, or weather and catastrophe can befall an investment. All of these events will affect the condition, income and expense, and eventual sales price of the property.

This is not a risk that is without mitigation. This risk can be diversified by selecting a portfolio of real estate with different building types, locations, and management expertise that understand how to best insure and stagger certain forms of risk.

Ensuring you have a well-diversified portfolio in growing markets is one way to mitigate real estate risk. And investors shouldn’t underestimate the importance of spending sufficient time at the outset to ensure the property is a good investment and that it fits well into their InSight-Full® financial plan. 

Operator Risk

A risk unique to DST investors is operator risk. Poor management in all real estate lowers both the income performance and the long-term capital return. When the property is not managed at an optimal level, return is always affected. Both a Property Manager and an Asset Manager manage DSTs, and each is assigned to different roles. 

A quick review of how management duties are divided: the Property Manager’s job is to implement the business plan, increase income, and lower expenses. As a result, net operating income will increase over time. 

The Asset Manager watches the property as if he owned it himself, managing the Property Manager with the same goal of increasing net operating income as much as possible, which increases your cash flow and appreciation potential. The Asset Manager also watches the market for sales opportunities and decides when it’s time to sell, reports to investors periodically, and is responsible for keeping the investors abreast of what’s going on with the property and answering any questions.

Liquidity Risk:

Most Real estate investors have long-term views of their holdings. However, DSTs are somewhat illiquid once acquired and may carry liquidation penalties to accommodate an early exit. So all investors should be prepared to stay invested for the term of the deal and have a long-term disposition if the DST is part of a multicycle tax mitigation scheme.

Managing liquidity might be the most important way to manage your exposure to real estate. Having a good idea of our expectations on liquidity can help manage other forms of risk in real estate. For example, investors in the early stages of a bear market who can “wait out” market conditions by lowering their liquidity requirements might find they can outlast negative consequences from other forms of risk.

Static Debt:

One challenge of a DST structure is that the property cannot be refinanced after the initial loan is in place nor can a lease be revised for a single tenant property. These factors are usually dealt with before the DST formation but sometimes the issues may arise later. If so, solutions can be complicated and expansive. Most sponsors will not change the debt structure of a deal once it is closed.

Tax Status and changes to Taxation:

As your income and taxation change in life, so too might the success and valuation of your tax mitigation strategy. It’s important to evaluate your long-term goals and expectations and work with a CFP® to make sure the tax scheme makes sense over a range of scenarios. 

According to the IRS and Revenue Ruling 2004-86, 1031 exchanges that use a DST are structured investments. This revenue procedure includes guidelines for taxpayers preparing ruling requests. They are only guidelines, however, and are not intended for audit purposes.

Remember, laws change, which means that different tax provisions may come into play today, and may create liabilities and penalties if they are not completed accurately or as laws change. 

More related articles:

Articles
Kevin Taylor

Tax Mitigation Playbook: What is “Boot” in a 1031 Exchange?

The term boot is commonly used when discussing the tax consequences of an exchange. However, the term “boot” is not used in the Internal Revenue Code or the Regulations. Which is a source of confusion. The “Boot” received is the money or the fair market value of “other property” received by the taxpayer in an exchange. You will be taxed on this portion – clients that work with our CFP’s® determine if that boot is the right amount to take inside of their InSight-Full® financial plan. Unlike property or non-qualifying property such as securities, cash, notes, partnership interests, etc. A taxpayer who receives boot (“unlike” property) will have to recognize gain to the extent of the net boot received or realized gain, whichever is less. This is Key: In exchanges, there are two types of boot: 1) cash boot and 2) mortgage boot. Boot is anything that is not considered “like-kind” that the taxpayer receives in an exchange. Cash Boot: This could include cash, property other than real property, or net debt relief. Any boot the taxpayer receives is regarded as taxable gain and will trigger a taxable event. Cash boot is any cash that the taxpayer receives once the exchange is finalized. Mortgage Boot: This version of boot is a debt instrument that is secured by real estate collateral that the borrower is obligated to pay back over a period of time with a predetermined set of payments, which include both the loan and interest. A mortgage boot occurs when the exchanger reduces a loan or debt from one property to the other.

Read More »

Account Types: Traditional IRA

A “Catch All” Retirement Plan Annual Contribution Max: $6,000 or $7,000 if over 50 years old.  Why we like Traditional IRA’s: Available to anyone Wide variety of investment choices Total control over the amount of control you want Ability to get Fiduciary level investment advice Easy to set up and contribute Tax-deferred growth Can make deductible Nondeductible contributions (these types of contributions are typically used for roth conversions or stashing more money away in tax deferred investments without the tax benefit now) Why we don’t like Traditional IRA’s: Low contribution limits Limited creditor protection No access to loans Income restrictions Can’t take out without penalty until 59 ½ unless you have a qualifying event  The InSight-full® financial plan will almost certainly have one of these as a core component for tax mitigation. An IRA is an Individual Retirement Arrangement and most investors will have at least one of these. A traditional IRAs is a tax-deferred savings plan that is mostly a “catch all” for any plan that savers have had in the past because it preserves the qualified status {not a Qualified account like a 401(k)} of those dollars.  The IRA is rarely the best option for maximizing current contributions. Anyone, regardless of age, can contribute to a traditional IRA provided that you have earned income. An IRA may be your only option if you don’t have access to an employer plan or you’re not self-employed. Traditional IRAs look a lot like a 401(k)’s, including the way it handles taxation and income. The contributions you make can reduce your taxable income (if you fall under the income limits for IRAs) for that year, and the money grows tax-deferred until you begin withdrawing on it.  Let’s highlight the differences you’ll see from a 401(k).  First, the contribution limits are much lower: $6,000 in 2020, or $7,000 if you’re 50 or older. Second, you will have broad choices between many different financial-services companies, and each of those companies may include a much wider range of investment options and strategies including stocks, bonds, ETFs as well as mutual funds insurance or even non-marketed securities. In some cases, we will use both an IRA and a 401(k) in the same year, but be careful: your IRA contributions may not be tax-deductible unless your income is below a threshold amount requiring some additional work to be done safely.

Read More »
Boulder Financial Advisors, Investing, Artificial Inteligence
Articles
Kevin Taylor

The investment potential of Artificial Intelligence (AI)

Investment in artificial intelligence (AI) has been steadily increasing over the past few years, with companies across various industries recognizing the potential benefits it can bring. The global AI market is expected to grow from $10.1 billion in 2018 to $126 billion by 2025, according to a report by MarketsandMarkets. This growth is fueled by increased investments in AI technologies and applications, including natural language processing (NLP) and machine learning (ML). One such application of AI technology is Chat GPT, which has immense potential to revolutionize the way we communicate. Chat GPT (Generative Pre-trained Transformer) is a type of AI model that uses deep learning algorithms to generate human-like text. It is designed to understand natural language inputs and provide relevant responses, making it ideal for chatbots, virtual assistants, and other conversational interfaces. Chat GPT has been trained on vast amounts of text data, allowing it to learn patterns and structures in language and generate responses that are contextually relevant and grammatically correct. The potential of Chat GPT lies in its ability to improve communication between humans and machines. By providing more natural and human-like interactions, Chat GPT can enhance the user experience and provide more efficient and effective solutions to common problems. For example, Chat GPT can be used in customer service applications to handle simple inquiries and direct customers to the appropriate resources. This can free up human agents to handle more complex issues and improve overall customer satisfaction. Chat GPT can also be used in healthcare applications to provide more personalized care and improve patient outcomes. By analyzing patient data and understanding their medical history, Chat GPT can provide personalized treatment plans and recommendations that are tailored to each individual’s needs. This can lead to more efficient and effective treatments, as well as better overall healthcare outcomes. The potential uses of Chat GPT are not limited to just customer service and healthcare applications. It can also be used in education, finance, and other industries to provide more personalized and efficient solutions. For example, in the education industry, Chat GPT can be used to provide personalized tutoring and support to students, helping them to better understand and retain information. In the finance industry, Chat GPT can be used to provide more personalized financial advice and investment recommendations. Investment in AI has the potential to revolutionize the way we communicate and interact with technology. By providing more natural and human-like interactions, Chat GPT can enhance the user experience, improve efficiency, and provide more personalized solutions to common problems. As investments in AI continue to grow, we can expect to see more innovative applications of Chat GPT and other AI technologies in the future.

Read More »

Pin It on Pinterest