Many people like to round out their portfolios with real estate investments.
Some start small. They purchase a starter house, rent it out and keep going from there. Others, including high-net-worth investors, like the idea of diversifying their holdings, and real estate is often a good alternative — especially when bond yields are weak and the stock market is volatile.
Both types of investors are looking for steady returns that can hold up against inflation.
As they age, however, many of those who truly enjoyed managing properties in their 30s and 40s find they just don’t want to do it anymore. They tire of answering late-night calls about clogged drains, worrying about finding new tenants or dealing with insurance policies and other paperwork.
They don’t want to tussle with the taxes, either, and the thousands of dollars they’ll owe Uncle Sam if they sell their properties.
Most are aware they can use a 1031 exchange (or, colloquially, a Starker exchange) to defer paying capital gains taxes on a sale by reinvesting the proceeds in a replacement property — but that doesn’t really solve their problem if they want to get away from being a landlord. So, when our clients come up against this situation, we discuss the pros and cons of using a 1031 exchange to put their money into something called a Delaware Statutory Trust (DST).
A DST ownership offers most of the same benefits and risks you have as an individual property owner, but without the management responsibility. Instead, you put your money into a fund along with other investors — sometimes 100, possibly more — to buy a property that will be professionally managed.
The asset might be a retail space, a health care center, a fitness center or an apartment building. Most are larger properties that some investors couldn’t get into unless they were pooling their money with others. But, as in the similar Tenants in Common (TIC) structure, there’s no majority vote on issues; one trustee makes all decisions. That means many of the nagging worries of ownership go away, which can make retirement decidedly more pleasant.
For example, our firm just started working with a widow who has more than $2 million in investment real estate all over the Washington, D.C.-Northern Virginia area: townhouses, condos, some single-family homes. But this was her husband’s thing, and he passed away several years ago. She is now in her 60s and managing these properties, and she knows that as she gets older, she’s not going to want to continue doing it.
After looking at the rate of return on her different properties — and calculating what she actually keeps after taxes, insurance and other expenses — we found that she’ll have a better return with a DST. It’s a win-win, so she’s decided to start selling off these properties.
When she dies, if the money is still in a trust, her children will inherit it on a stepped-up cost basis, just as they would with regular real estate, and they will collect the yield until the DST liquidates. At that point, they can do another exchange, take the money out or handle it any way they like.
There are downsides, of course. Investors should know that their cash will be tied up for the length of the fund, which is usually about seven to 10 years but could be longer.
And there are specific rules for how you set up the investment. If your intent is to use the trust with a 1031 exchange, you must be sure it meets the requirements of Revenue Ruling 2004-86. That includes using a qualified intermediary — an attorney — because the money from the sale cannot go into your personal bank account. It must go to the attorney and then into the trust.
You also should talk to your tax professional if you’re considering this strategy.
And you’ll want to work with a knowledgeable, experienced financial professional. An independent fiduciary can help you make sure the DST sponsor is solid and above-board — and that a DST fits with your overall retirement plan and your long-range goals.
Kim Franke-Folstad contributed to this article.
This article and the opinions in it are for general information only and are not intended to provide specific advice or recommendations for any individual. We suggest that you consult your accountant, tax or legal adviser with regard to your individual situation.
Examples are for illustrative purposes only and may not be indicative of your situation. Your results will vary.
Megan Clark is not affiliated with, or endorsed by Kiplinger.com.
Megan Clark is CEO & Executive Wealth Manager at Clark & Associates Inc. Financial Solutions and is an Investment Adviser Representative and Insurance Professional. As a financial adviser, she is passionate about helping families create a holistic financial plan, and she often holds "For Women By Women" informational seminars to reach out and help assist women in pursuing their goals. Clark is a graduate of the University of Virginia. Investment Advisory services offered through Brighter Financial Capital Management LLC, a SEC Registered Investment Adviser.
Securities offered only by duly registered individuals through Madison Avenue Securities, LLC. (MAS), Member FINRA & SIPC. Advisory services offered only by duly registered individuals through Brighter Financial Capital Management, LLC, a registered investment advisor. Clark & Associates, Inc. Financial Solutions, Brighter Financial Capital Management, LLC and MAS are not affiliated entities.
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