Keep rentals or 1031 them to a Delaware Statutory Trust (DST) ?

Question

Should an investor keep his rental properties or do a 1031 exchange to several Delaware Statutory Trusts (DST) ?

Scenario:

- The investor currently has about 10 rental properties that are all paid off.

- The investor's net worth has grown significantly over the years and is starting to get tired of the hassles of being a residential landlord.

- Because of the increased net worth and the liability of being a landlord, the investor will also prefer to have less liability.

- The investor would like to be able to do a 1031 exchange of all 10 rental properties for a single larger commercial property, but it's hard to sell all 10 rental properties at one time for a good price.

- Thus, the investor is thinking about selling each rental property individually (one at a time) and do a 1031 Exchange into a Delaware Statutory Trust (DST) after each sale. So after selling all 10 properties, the investor would have 10 different Delaware Statutory Trusts, which is more diversified that having just one Delaware Statutory Trust.

Is this a good plan? Any flaws with this plan? Any tips on how to improve this plan?

Thank you.

Dave Foster · Answer

@Nikki Lee, Its a plan. Its a common plan. It might be a good plan depending on the particulars. As investors transition there is a common pattern of desiring to move from more active to more passive investing. Usually this transition has a negative impact on ROI. So an investor has to consider and balance their income need vs the desire to become less active.

DSTs typically don't throw off as much cash as an individually managed asset (although that's not always the case, especially if there's no leverage involved). That's the sacrifice you make for going the route of the most secure, tax effective and passive route.

In your investors case it's not just the gain but the depreciation recapture that could kill their return if they don't do the 1031. So that might dictate that they 1031 their properties. And if that's the case then DSTs, TICs, NNN commercial, and managed residential (in order from most to least passive roughly) are the only options.

In general what you're describing is exactly the path that most of our clients take as they go through their investor life cycle.

Dave Foster · Answer

@Nikki Lee, Many of the Delaware Statutory Trusts and Tenants in Common properties are actually set up exactly that way. The real estate is a NNN commercial property and the investors are buying a fractional interest in the DST that owns the property or a tenant in common interest in the TIC.

Nikki Lee · Answer

@Lisa Taylor, is it possible to do a 1031 exchange and buy just a fractional share of a NNN investment? Or do NNN investments require that you buy 100% of the building? In other words, if the investor sells just one rental property that is only worth $150k, can the investor do a 1031 exchange and buy just a fractional share of a NNN investment? If yes, where can we find such NNN investments?

Lisa Taylor · Answer

@Nikki Lee As per Request

You can change the numbers depending upon your goal. Since the investor wants to get rid of the management responsibilities in this case, both DST and NNN investment offers management-free investment. So, you can do a 50-50 in both (50% in DST & 50% in NNN) do you wish to sell out the entire portfolio. The reason why I had suggested to keep 50% of the portfolio with existing rental properties is that by doing so, the investor won't have to find 10 different buyers, which could be an arduous task. Selling out half of the portfolio will be easy as compared to going all out. Choice is yours.

Nikki Lee · Answer

@Lisa Taylor, thank you for your suggestion. This investor currently has 10 rental properties in his investment portfolio and each property is worth about the same value. So you are basically suggesting that 30% of the portfolio should go into a DST and 20% of the portfolio should go into a Triple Net (NNN) lease. The remaining 50% of the portfolio should remain with the existing rental properties. Is that correct?

30% - DST

20% - Triple Net (NNN) lease

50% - Traditional Rental Properties

Why do you suggest this overall allocation?

30% - DST

20% - Triple Net (NNN) lease

50% - Traditional Rental Properties

Why do you suggest this overall allocation?

Lisa Taylor · Answer

@Nikki Lee May be the investor is running too fast. Though it's possible, exchanging 10 rental properties for one real estate won't be that easy. We recommend the investor do a 1031 exchange for half of the total asset in DST and Triple Net (NNN) lease. As the main issue in this case is growing management responsibility, both DST and NNN investments can be the cure. If the investor sells 3 of his rental properties and reinvests the proceeds into a DST, he will have bigger share in the DST property. Plus he can trade the other two investment properties in the same way and reinvest the proceeds in NNN properties. A triple net lease requires the tenant to pay all operating expenses associated with a property. So, the investor will be free from all kinds of liabilities. The remaining 5 properties, he can keep in the same way as he has till now. This way half of this liabilities will be gone in no time, and after some time he could do a 1031 exchange for those remaining 5 properties as well.

Isaac S. · Answer

Please let me know when you find the answer!

Keep rentals or 1031 them to a Delaware Statutory Trust (DST) ?

Keep rentals or 1031 them to a Delaware Statutory Trust (DST) ?

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