3 reasons why 1031 investors seeking a sole-ownership investment end up buying a DST
One of the most common responses I get from 1031 investors is that they have something else in mind to buy. What they fail to consider is that the DST can still be used in three primary ways.
1. The 1031 investor finds a replacement property with a purchase price that is less than the sale price of their relinquished property.
If you have cash left over from the sale of a 1031 property it will be taxed as capital gains. Rather than pay the taxes, a DST can be used to make up the difference. In other words, 1031 investors who are open to investing in a DST won’t be limited to buying sole-ownership properties that are only of equal or greater value. This means more inventory/options to choose from, which can lead to greater investment success. This also means greater diversification which helps reduce investment risk.
2. The 1031 investor has some “debt” that needs to be replaced.
The sale price of a 1031 investor’s property must be replaced in order to avoid having to pay any taxable boot. It is not technically the debt that needs to be replaced. If however, the 1031 investor does not have this cash available to add to the transaction, they will need to put financing on the replacement property that is equal to or greater than the debt from the relinquished property.
Finding a suitable replacement property, getting it under contract, and then completing the inspections and financing within the short timeframe allotted by the IRS can be very challenging. Rather than having to worry about getting a new loan on the replacement property, a 1031 investor can use the debt that comes with a leveraged DST.
Take for example, if an investor exchanges a $1,000,000 property with $200,000 of debt (the loan balance). Assuming the DST is leveraged at 50%, an investor can buy $200,000 worth of that DST. This would equate to $200,000 of debt and a total purchase price of $400,000. As long as the 1031 investor is accredited, they automatically qualify for the DST loan and the debt is replaced. This strategy also provides additional diversification for the 1031 investor.
3. The 1031 investor is unable to find a suitable replacement property or is unable to complete their financing and due diligence prior to their 45-day identification deadline.
Once again, finding a suitable replacement property within 45 days is a difficult task. Even if a 1031 investor is lucky enough to get an offer accepted within their 45-day deadline, it is almost impossible to then complete the financing and due diligence within that timeframe. Often, 1031 investors usually need several additional weeks beyond this date to complete the purchase. What many savvy 1031 investors will do is also identify a DST as a backup. The DST can then remain available for several weeks past the identification deadline. If financing falls through on the targeted replacement property, or something else comes up, a 1031 investor can fall back on the DST so they don’t get stuck having to pay capital gains.