Chapter 4: Manage Debt
How Real Estate Investors Can Use Delaware Statutory Trust (DST) Properties to Replace Debt in a 1031 Exchange Because DST properties already have debt prepackaged into the investment, they make the debt replacement component of a 1031 exchange relatively simple to accomplish.
By Alex Madden, Vice President, Kay Properties and Investments, LLC
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avvy real estate investors understand the primary reason for selling and buying real estate via 1031 exchange is to defer capital gains tax that would otherwise be due on the sale. By “exchanging” one or more pieces of property for one or more like-kind pieces of equal or great value helps the investor defer capital gains taxes. However, one of the critical requirements that must take place to make any 1031 exchange work in the eyes of the Internal Revenue Service (IRS) and the individual real estate investor is to ensure that some form of debt replacement occurs in the event the relinquished property has been leveraged. Debt replacement practice basically states that when an investor acquires a replacement piece of property in a 1031 exchange, they must incur a level of debt that is equal to or greater than the amount owed on the former
piece of real estate at the time of sale.
A Simple Example Of How A Delaware Statutory Trust 1031 Exchange Can Help In Debt Replacement To illustrate the concept of how a Delaware Statutory Trust 1031 exchange can greatly help solve the debt replacement equation, imagine an investor exchanging a piece of real estate with a net value (sale price minus closing costs) of $2 million. The investor has a mortgage on the property of $750,000. That $750,000 will be paid off at closing and must be replaced as part of the acquisition. In order to complete the exchange, the acquired property must be worth $2 million or more. The investor has several options and may replace that $750,000 mortgage debt or be hit with capital gains taxes:
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Take out another mortgage of $750,000 (or more if the new property costs more than the net sales price.)
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Combine a smaller mortgage of, say, $500,000 plus adding additional cash of at least $250,000 (to equal the original debt figure.)
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Inject $750,000 which in cash which would basically replace the original debt with cash.
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Invest in a Delaware Statutory Trust 1031 exchange that already has built-in debt.
How to Replace Debt using Delaware Statutory Trust 1031 Exchanges DST 1031 Exchanges already have debt prepackaged into the investment, so they make the debt replacement component of a 1031 exchange relatively simple to accomplish. In addition, investors also have greater flexibility because they
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