Delaware Statutory Trusts

Innovative tax-deferral vehicles for 1031 Exchanges

BY AARON MASTRIANI, CPA AND JEFF MITCHELL, CPA, MT

IT’S IMPOSSIBLE to discuss Delaware Statutory Trusts without talking about 1031 Exchanges first. A 1031 Exchange gets its name from Section 1031 of the Internal Revenue Code (IRC). In general, a 1031 Exchange allows an investor to defer paying capital gains tax on a property sold by subsequently using the proceeds to purchase another “like-kind” asset. There is no limit on how often a taxpayer can utilize a 1031 Exchange. The gain can be rolled over from one piece of investment real estate to another multiple times. Although the taxpayer may profit on each transaction, they will avoid paying tax until it is ultimately sold for cash down the line. This appealing tax strategy has many rules that need to be followed to ensure the transaction is valid and qualifies for tax deferral, thus making it important to consult with a CPA prior to any action.

One thing to acknowledge is that not long ago, there was speculation that President Biden had plans of repealing the current 1031 Exchange laws and pulling the rug out from under real estate investors. However, after Congress passed the Inflation Reduction Act without proposed changes to Section 1031 of the IRC, it became likely that 1031 Exchanges are not going anywhere.

How a 1031 Exchange Can Help with Cash Flow

Cash flow analysis and forecasting is an essential aspect of managing a growing business. It is the process of examining and projecting the inflow and outflow of cash in a company, and it helps business owners and managers understand their financial position and make informed decisions. One of the key benefits of cash flow analysis and forecasting is that it allows businesses to anticipate and plan for potential cash shortages.

Incorporating tax planning into cash flow analysis and forecasting can also help businesses make better investment decisions. By understanding the tax implications of different investments, businesses can choose the ones that are most likely to generate positive cash flow and minimize taxes. For example, businesses can take advantage of tax-deferred investment options like a 1031 Exchange, which allows them to defer capital gains taxes on the sale of a property. A 1031 Exchange can be a powerful tool to help businesses improve their cash flow while growing their operations.

What is a Delaware Statutory Trust?

A Delaware Statutory Trust (DST) is a legal Delaware entity that provides ownership in commercial real estate investment.

A DST can hold any type of commercial property: retail space, office buildings, industrial parks, apartments, etc. A single DST can hold multiple properties at one time and allows multiple investors to each hold an undivided beneficial interest in the trust. The reason why DSTs are so attractive to real estate investors is because in 2004, the IRS ruled that a DST is eligible as replacement property in a 1031 Exchange. This means that investors who sell property can defer tax on the gain by investing the proceeds into a DST. Essentially, a DST qualifies as a “like-kind” investment for 1031 Exchange purposes and is an alternative to a direct purchase.

Along with tax-deferral, a DST provides many attractive benefits. As real estate investment goes, the barriers to entry are fairly low. Investors can generally participate in a DST with $25,000 cash or $100,000 if participating in a 1031 Exchange. The structure of a DST takes the responsibility of managing the property and making decisions out of the hands of investors and transfers that responsibility to professional management. A DST offers diversification. Instead of restricting investor capital to one property, a DST allows an investor to expand investment to varying geographical markets. A DST also offers liability protection and shields investors from any liabilities involving the individual properties.

These tax-deferral vehicles can be advantageous for many investors. DSTs and 1031 Exchanges can be complex and have many requirements that need to be met. Investors should consult with their CPA for expert guidance prior to any action.

Aaron Mastriani, CPA is a senior tax associate and Jeff Mitchell, CPA, MT is senior vice president, both of Siegfried Advisory. Siegfried Advisory provides leadership, financial, transaction, and tax advisory services to entrepreneurial organizations and high net worth families.