Utilizing a Deferred Sales Trust, investors can defer capital gains taxes over time. Deferred Sales Trusts provide an alternative to 1031 exchanges for deferring capital gains taxes on appreciated assets.
Key Highlights and Takeaways
Your Appreciated Asset: 1031 Exchanges are typically used to sell and buy real estate on a tax-deferred basis, while DSTs are typically used to sell businesses on a tax-deferred basis.
Key Takeaways. A 1031 exchange allows real estate investors to defer capital gains taxes by reinvesting the proceeds from the sale of a business or investment property into a new, "like-kind" property. The replacement property in a 1031 exchange should be of equal or greater value to avoid paying taxes immediately.
Lack of Liquidity- Exchanging properties continually can tie up funds in real estate, making it hard for an investor to access liquid capital if required. While real estate can be a profitable investment, it's not as liquid as some other assets.
The most important thing to understand is that long-term realized capital gains are subject to a substantially lower tax rate than ordinary income. This means that investors have a big incentive to hold appreciated assets for at least a year and a day, qualifying them as long-term and for the preferential rate.
There is no assurance that a property will perform as projected and DSTs are subject to economic volatility, tenants not paying their rent timely, and other traditional risks of owning and operating real estate.
In general, we find that commissions range from 6% to 9% for DSTs. Our approach is to charge a flat consulting fee that is about 1/2 to 1/3 of the commission rate and then to credit our clients with whatever commission they would have paid had they dealt with a commission-driven broker.
With all that being said, the range for returns that an investor can expect is between 4% – 9% on their cash on cash monthly distributions. One major factor that contributes to the DST's rate of return is the type of property or properties that are being held and managed by the same DST.
An easy and impactful way to reduce your capital gains taxes is to use tax-advantaged accounts. Retirement accounts such as 401(k) plans, and individual retirement accounts offer tax-deferred investment. You don't pay income or capital gains taxes on assets while they remain in the account.
Here are examples of properties ineligible for a 1031 exchange: Primary residences: A 1031 exchange is specifically intended for investment or business properties. Personal properties are not eligible. Vacation homes: Vacation homes generally do not qualify if used for personal reasons.
Here's how it works: Taxpayers can claim a full capital gains tax exemption for their principal place of residence (PPOR). They also can claim this exemption for up to six years if they move out of their PPOR and then rent it out. There are some qualifying conditions for leaving your principal place of residence.
Missing Deadlines
They have 180 days to acquire replacement properties, but that deadline also starts ticking away with the closing on relinquished properties. If an investor misses either deadline, it will invalidate the 1031 exchange.
For this reason, it is possible for an investment property to eventually become a primary residence. If a property has been acquired through a 1031 Exchange and is later converted into a primary residence, it is necessary to hold the property for no less than five years or the sale will be fully taxable.
A 721 Exchange, also known as an UpREIT, enables institutional property owners to contribute their investment property to a Real Estate Investment Trust (REIT), deferring capital gains taxes while gaining access to REIT benefits.
It's important to note that DSTs are generally illiquid investments with limited secondary market opportunities. However, investors can still exit their investment by selling their beneficial interests to other accredited investors or through a secondary market platform.
On average, setup fees and maintenance fees may be higher than other tax deferral strategies. An attorney usually charges a fee to set up the trust, often 1.5% of the asset's value of the first $1 million and 1.25% of anything over $1 million.
Investors would do well to remember that, similar to all other rental properties, the distributions from their Delaware Statutory Trust will be taxed as ordinary income.
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In a DST, investors own a beneficial interest in a property, and the trustee manages the property on their behalf. In a 1031 exchange, investors own the property outright and are responsible for managing it themselves or hiring a property management company.
“The retail industry still seems to be the biggest advocate for daylight saving time. They argue that extended evening daylight encourages people to shop after work and boosts foot traffic.
The taxation of capital gains places a double tax on corporate income. Before shareholders face taxes, the business first faces the corporate income tax.
Taxpayers who don't qualify to exclude all of the taxable gain from their income must report the gain from the sale of their home when they file their tax return. Anyone who chooses not to claim the exclusion must report the taxable gain on their tax return.