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Make money in real estate with DST and 1031 exchange

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 If you have ever owned an investment property, you may have heard of a 1031 exchange. If you research the IRS definition of 1031 exchange, you get this: Whenever you sell business or investment property and you have a gain, you generally have to pay tax on the gain at the time of sale.



Internal Revenue Code (IRC) Section 1031 provides an exception and allows you to postpone paying tax on the gain if you reinvest the proceeds in similar property as part of a qualifying like-kind exchange. Gain deferred in a like-kind exchange under IRC Section 1031 is tax-deferred, but it is not tax-free.



Imagine the amount of tax savings you could have if you are successful at turning properties with capital gains over your lifetime. Not everyone can or should be involved in managing their own investment properties. A way to take advantage of this type of investment without you being involved in all aspects of managing the property is to invest in a DST.



A Delaware Statutory Trust (DST) is a newer version of the original TIC or Tenants in Common. The TIC was established in the late 1970s. Recently, I had the good fortune to meet the man who created the first TIC.  And I learned how the TIC transitioned to the DST.



TICs evolved through the years as a way for investors to diversify investment dollars into multiple types of properties and geographical locations. TICs are, in short, a way for multiple investors to participate in a professionally managed investment property.



You still have title and are on the deed of the property. This way you can participate in the tax benefits of true ownership without all the management headaches. This can really be an advantage for those traveling on yachts and unable to personally keep tabs on their property.



For decades, there did not seem to be a down side to TICs. With our most recent real estate downturn, however, lessons were learned, and the DST was created.



With a TIC, every investor had to vote on issues. This included such things as offers to sell, improvements, etc. A few years ago, investors thought real estate would just keep going up in value and did not want to sell. All it took was one investor to vote no and a deal was lost.



Can you image how the other investors felt when the real estate market tanked and there were no more offers and tenants could not pay rent? Now, many are stuck with an upside-down property because of that one voter.



Unlike TICs, DSTs are managed by a trustee who makes decisions that are best for all investors. Of course, the trustee has guidelines that are laid out in the prospectus along with qualifications to invest in these types of investments.



Other interesting bits about the 1031 exchange: Many investors begin their real estate investments with a DST. As an example, if a client has $100,000 to invest, I would suggest four different properties at $25,000 each, such as BJ’s Wholesale, Dollar Store, Walgreens, FedEx, all in different states and cities.

As a captain or crew who travels all over the world, this makes it much easier to manage without the headaches of dealing with tenants.



If done properly, these properties can be sold for a profit, with the proceeds sent to a QI or Qualified Intermediary. This is a company that holds and transfers money to the next qualified property so that you follow the IRS guidelines and don’t pay capital gains tax on the property you just sold.



Now let’s identify the advantage of this 1031 exchange process. When you have $100,000 in real estate and you receive rental or dividends of, let’s say, 7 percent, this would be $7,000 a year in income.



Let’s say the property is sold and you have a capital gain of 20 percent. Now you go through the QI and do a 1031 exchange and buy new properties with the $120,000. You pay no taxes on your $20,000 capital gain.

Let’s say you get the same 7 percent dividend on the new property or DST, but it’s now on $120,000 so it comes to $8,400 a year in income, or $1,400 more than the year before.



Once you get this buy-sell plan going, this is a repeatable retirement plan for the real estate portion of your portfolio.



There are many more details, types and terms of 1031 exchanges. It can be done with businesses, planes, properties, etc.



Information in this column is not intended to be specific advice for anyone. You should use the information to help you work with a professional regarding your specific financial goals.

 

Capt. Mark A. Cline is a chartered senior financial planner. Contact him at +1 954-764-2929 or through www.clinefinancial.net. Comments on this column are welcome at editorial@the-triton.com.

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