Can a Deferred Sales Trust Do a 1031 Exchange?

The DST can be used as a vehicle that does what a 1031 exchange does, without the problematic timelines and other stringent requirements, but it also can do so much more. In order to understand the pros and cons of a DST and a 1031 exchange and the benefit they give you, you must first understand 1031 exchanges themselves.

1031 Rules

As you might expect with anything sanctioned by the IRS, you must follow many rules in order to do a 1031 exchange. The primary ones regarding real estate swaps consist of the following:

  • Both properties must be located in the United States.
  • They must be of “like kind,” broadly defined as virtually anything other than personal property.
  • You must own them for business or investment purposes only.
  • They must be of at least equal value if you want to defer 100% of your capital gains tax obligation.
  • You must not receive “boot,” i.e., exchange your property for a property of lesser value, if you want to defer 100% of your capital gains tax obligation.
  • Your name and tax ID number that appear on the title of the property you’re exchanging must also appear on the title of property you’re exchanging it for.
  • You must, within 45 days of the sale of the property you’re exchanging, designate up to three potential like-kind properties you’re interested in buying.
  • You must, within 180 days of the sale of the property you’re exchanging, complete the exchange by purchasing or otherwise receiving the replacement property.

1031 Downsides

Traditional 1031 exchanges are both complicated and complex, with several downsides. Chief among these is the 45-day window during which you must find a like-kind replacement property. Oftentimes this is not sufficient time for you to find a suitable property that meets your investment goals. Additionally, if your attempted exchange fails, you’ll have to immediately pay capital gains tax on whatever profit you realized on the sale of your original property.

DST Solutions

A deferred sales trust can solve all of these problems. In fact, a DST is an effective investment and estate planning tool that’s a highly flexible alternative to traditional 1031 exchanges. If you stand to profit by at least $250,000 on a 1031 exchange you’re contemplating, a DST can not only serve as your capital gains deferral strategy, but can also grow your wealth by investing 100% of the proceeds of the property you intend to sell.

Comparing Both Vehicles

If you want to compare both a DST and a 1031 exchange only for purposes of reinvesting in real estate, the pros for DST would include:

  • More flexibility in the time you can take to find your upside property
  • The ability to buy property that is more or less expensive than what you sold and still defer all your taxes
  • The ability to obtain more or less of a mortgage on your replacement property without realizing a taxable event
  • The DST may allow you to generate greater depreciation writeoffs on your replacement property

The cons are that a DST will be more expensive to complete than a 1031 exchange because of the legal fees and set up fees which are greater than exchange accommodator fees. Additionally, you will, in a sense, be partnering with a Trustee, whereas there is no Trustee role in a 1031 exchange.

Learn How a DST Can Work For You

Contact Reef Point online or call us at (714) 581-5376 to learn more about DSTs.