Alternative Investments and CRE 2025 Ground Hog Day

The traditional holiday known as Ground Hog Day (celebrated Feb 2 annually) is more of a folk lore event rather than an actual weather prediction. As a side note, in case you missed Punxsutawney Phil this year the groundhog (actually a woodchuck) saw his shadow and predicted 6 more weeks of winter.

February 7, 2025

By Al DiNicola, AIF®
DST 1031 Specialist
NAMCOA® – Naples Asset Management Company®, LLC
Securities offered through MSC-BD, LLC, Member of FINRA/SIPC

Phil, over the years, is right 40% of the time. Commercial Real Estate forecasting may have a better percentage in predictions.

During the month of January and spilling into February commercial real estate practitioners, financial advisors and real estate investors attend multiple Webinars reviewing 2024 and looking toward predictions for 2025. Is there a real estate ground hog day?

You may remember the 1993 movie called Groundhog Day. In this comical movie a man (played by actor Bill Murray) relives the same day over and over again. Because of the movie, the phrase “Groundhog Day” is now often used to describe repetitive, monotonous situations.

“Real Estate Groundhog Day” is not a widely recognized term, but it could refer to the repetitive cycle often experienced in the real estate industry. This could include:

Market Cycles – The recurring patterns of boom and bust in real estate markets, where property values rise and fall in predictable cycles.
Buyer’s and Seller’s Behavior – The repetitive nature of buyer hesitations, seller expectations, and negotiation tactics that agents deal with regularly.
Agent Routine – Real estate professionals often feel like they are reliving the same tasks daily, such as prospecting, showing homes, negotiating deals, and handling paperwork.
Seasonal Trends – The real estate market tends to follow seasonal patterns, with increased activity in spring and summer and slowdowns in fall and winter.

2025 Commercial Real Estate and Alternative Real Estate Outlook

For investment advisors and representatives we do experience cycles and compare and contracts past trends to establish some type of predicative future. Many look to cause and effect in the markets.

Many of the same takeaways in the commercial real estate analysis can transfer to the Delaware Statutory Trust (DST) investment opportunities, Opportunity Zones as well as the direction of private equity into real estate development. Private equity as well as individual investors are moving into the alternative real estate space for a variety of reason.

Many of the sessions we have attended provide the same key takeaways:

With the second largest drawdown of CRE valuations on record, a compelling entry point is on full display.
Looming debt maturities and stressed capital structures will support significant opportunity for well-capitalized buyers.
Slower economic growth will drive more focus on the intersection between real estate and demographic trends.
Housing affordability, migration patterns, and immigration policy will be critical trends to consider when making investment decisions.
Construction starts are down significantly across commercial real estate, setting up for strong fundamentals.

Wall of Debt Maturities

The massive transaction volume from 2021 to 2023 created a great deal of debt to go with it. Much of the debt originated between 2019 and 2022 will be coming due in the next 12 to 24 months.

Affordability

Housing affordability will drive residential rental demand. Despite an increase in mortgage rates, the Case-Shiller Home Price Index is at an all-time high. This is driven by the continued demographic demand for housing, coupled with an extremely low supply of existing homes for sale.

Migration Patterns

Both domestic population migration between states and immigration from abroad will have an outsized impact on commercial real estate demand going forward, especially as organic growth from births continues to wane. It is estimated that 75 percent of population growth in the next decade will come from immigration. The profile of potential renters will also vary significantly depending on the migration timing a market experiences. International migration is concentrated on a few key states, with Florida, California, and Texas receiving the largest share.

Supply and Demand Dynamics Across High-Conviction Sectors.

The demographic backdrop will drive supply/demand dynamics for commercial real estate throughout the next decade. Given the slow-growth macroeconomic environment, the strongest real estate sectors will be those whose demand is tethered to life events rather than economic growth. Those same real estate sectors also benefited from the low interest rates of 2020 to 2022, seeing a boom in construction starts during that time period.

Interest rates seem to be a topic of discussion by many and look towards a trend lower. However the market with make a move with or without significant changes. Seller of actively managed real estate will seek to move into passive management. Investors with capital gains will continue to seek tax deferral through 1031 tax deferred exchanges (some utilizing DST for passive income and tax deferral). Other investors with capital gains may seek to invest into Opportunity Zones for long term compounding potential returns.

Over the next few weeks, we will provide a review into specific asset classes and the projection. Will we repeat the same results as 2024, or will this year see appreciable improvements in the markets?

We want to thank many of the sponsors who have provided 2024 and 2025 analysis including Inland-Investments, Capital Square, Cantor Fitzgerald, Brookfield, Starwood and others.

NAMCOA® is a SEC registered investment advisory firm that provides comprehensive portfolio management, financial planning, and fiduciary decision-making services on behalf of retirement plan sponsors. Our Difference is summarized by our fiduciary approach which enables us to better meet portfolio and retirement plan objectives, resulting in stronger risk adjusted returns for investors and peace of mind for Clients. We also focus on alternative real estate investment. Many real estate investors are seeking tax deferred solutions utilizing §1031 exchanges or Opportunity Zones.

DSTs are not for all investors. The acquisition of a DST is for accredited investors only. Contact your investment adviser for additional details on how a DST may be a solution to your 1031 Exchange and suited for your investment future. For more information on how to properly set up an IRC 1031Tax Deferred Exchange or if you are an accredited investor and would like additional information on a DST contact Al DiNicola at 239-691-8098 or email adinicola@namcoa.com.

This is not an offer to purchase or solicitation to purchase any security, as such be made only through an offering memorandum or prospectus. Investing in securities, real estate, or any investment, whether public or private, involves risk, including but not limited to the potential of losing some or all of your investment dollars when you invest in securities. You should review any planned financial transactions that may have tax or legal implications with your personal tax or legal advisor. NAMCOA, LLC is a Registered Investment Advisor, regulated by SEC (Securities and Exchange Commission). Our corporate office is located at 999 Vanderbilt Beach Road, Suite 200, Naples Florida 34108. Securities Offered through MSC-BD, LLC, Member of FINRA/SIPC. 8215 SW Tualatin- Sherwood Rd, Suite 200, Tualatin, OR 97062. MSC-BD, LLC and NAMCOA are independently owned and are not affiliated.

Thank you.

CRE Market Update 2025 and 1031 Exchange Trends ~ Part 2

There was much anticipation, during the previous administration, that the long-standing Section 1031 tax deferred exchange provision would see changes. There were several proposals, from elimination (of what some referenced §1031 a loophole), to limiting the exchange dollar limits, to other strategies, none of which came to fruition.

January 27, 2024

By Al DiNicola, AIF®
DST 1031 Specialist
NAMCOA® – Naples Asset Management Company®, LLC
Securities offered through MSC-BD, LLC, Member of FINRA/SIPC

We have previously written about the reasons why. Advisors, CPAs, real estate professionals and most importantly the individual investors feel comfortable the program will stay intact, at least we are hopeful.

In Part 1 we commented on real estate prediction, interest rate changes, financing, inventory supply, asset classes and short-term rental in certain areas. (See Part 1 – 2025 CRE Trends). We will address a few other areas and amplify.

Can you Refinance? There continues to be concerns regarding the ability of investors (especially large investors) to refinance maturing lower rate loans to higher interest rates. We have heard of the projected number of loans maturing over the next two years. The estimates range from $700M to $2 Trillion depending on the source and interpretation of the data. No matter what the dollar amount will be, the individual investor will be focused on how to reposition their asset either through refinancing or reselling.

A lot of that will be determined by the banks that are holding the loans. Some analysts have often used the phrase “extend and pretend” but some banks may potentially use some of the same strategies. In banking, the term “extend and pretend” refers to a practice where banks or lenders extend the terms of a loan (i.e., by lengthening the repayment period or restructuring it) instead of addressing underlying issues, such as the borrower’s inability to repay. This is often done to avoid recognizing a loan as non-performing or impaired on the bank’s balance sheet, which could require the bank to set aside additional reserves or take a loss.

There may be an increase in the volume of activity simply based on the fact that there are maturing loans, and some investors want to get out from under the loans. The challenge many investors will face when doing a §1031 exchange is that the loans that are being paid off need to be replaced in order to have a valid §1031 exchange unless the investor can provide fresh cash in place of a mortgage. Delaware Statutory Trusts (DSTs) may assist certain investors with debt being replaced with non-recourse loans.

Interest Rates and Transaction Volume

A reduction in a few basis points in interest rates is expected to boost 1031 transaction volume. This may push an upward trend in residential and commercial exchanges. Investors evaluating making moves may focus on tax deferral as well as NOI or distributions being paid.

Seller Financing

Traditional financing challenges will lead to more seller-financed transactions. This may become problematic with sellers leveraging §1031 Exchanges. We will follow up with another article on the benefits and drawbacks of seller financing.

Shifts in Asset Classes

Multifamily, industrial, self-storage, and certain necessary retail properties are expected to see robust activity as investors use §1031 Exchanges to defer taxes. Certain investors may move from one asset class to another. Investors utilizing DST may have an advantage in selecting several asset types and geographic locations as replacement properties. This diversification spreads the risk of real estate over a greater number of properties. For example, an investor selling a residential rental property for $500,000 may acquire 3-5 different DSTs (typically $100,000 minimum in a DST) and assemble a portfolio of real estate rather than one property. If the relinquished $500,000 property has debt, the DSTs provide non-recourse debt which may be viewed by investors as favorable.

Shift to Passive Investments

Investor demographics continue to suggest a move away from active management. An increase in management-intensive properties being exchanged for passive investment types like NNN (Triple Net Lease) and DSTs is expected.

Geographical Shifts

Local regulations may restrict the rental of certain real estate. New policies and zoning regulation may change the number of rentals per year or per month (as in the case of Airbnb investors) that will prompt investors to move their investments to more landlord-friendly areas.

The need for more housing

In many locations there is a movement for permitting Additional Dwelling Units (ADU). The need for residential units in many locations has prompted municipalities to seek alternatives such as permitting ADU to be added to existing properties. A single-family home may have enough room to build a smaller home or garage/carriage home on the same property. Hence the name additional dwelling unit (on the same property). The increase in unit counts may prompt investors to look at §1031 opportunities. There may also be a combination of mixing commercial with residential offerings known as Mixed-use. This diversification may appeal to a variety of investors, especially those seeking §1031 Exchanges.

Location, Location

The migration of people and to certain extent investment dollars are moving to the southern smile states (as they are known). These are known as retirement-friendly areas. Rumors of warmer weather (although maybe not in the southeast in January 2025), lower cost of living, favorable tax conditions, and areas friendly to retirees, continue to be in demand for investors.

2025 may be a fluid year with opportunities for investors. Potential legislative changes, market dynamics, interest rates, net operating income and other strategies are trends we will continue to monitor. The DST strategy as well as Opportunity Zones should continue to be of interest to advisors as well as investors. Another trend to watch is the IRA to ROTH conversion strategy.

Thank you.

January 2025 Landscape Review 2024 DST Equity Raise Increased 12% over 2023

During 2024 we monitored the equity raised in the Delaware Statutory Trust (DST) market. With much anticipation the overall market did achieve a 12 percent increase when compared to 2023.

January 16, 2024

By Al DiNicola, AIF®
DST 1031 Specialist
NAMCOA® – Naples Asset Management Company®, LLC
Securities offered through MSC-BD, LLC, Member of FINRA/SIPC

There was an equity raise (from investors) of $5.67 Billion during 2024. This was reported by Mountain Dell Consulting who engages and tracks activities from sponsors of Delaware Statutory Trust (DST) and TIC Market Equity investment.

2024 Reversed the Contraction

Macroeconomic headwinds impacted the equity raise in 2023. The 12% increase in equity raise (2024 year over year) is an encouraging sign for investors. 2023 may have been the “Valley” in transaction volume. This 2024 increase may be evaluated as a mild rebound, or a thawing of the transaction volume and more transactions were flowing again. In looking back in 2023 there were many escrows that were delayed and fell out due to many issues facing investors. The increase in 2024 may be due to people getting used to higher rates. (Although I remember my first mortgage in Florida was at 14%). Investors are accepting the reality of higher rates (and maybe rates will come back down). There are other macroeconomic headwinds affecting many classes of real estate (multifamily, student housing, etc.). The drastic rise in insurance premiums and other operating costs effects the bottom line. Contraction of the DST market was anticipated given a variety of market dynamics, the least of which was the rising interest rates. The rise in interest rates caused an overall slowdown in the real estate market. Investors holding traditional real estate may have seen fewer buyers. These buyers may have needed access to capital at an acceptable borrowing rate. However, there is much expectation that conditions will improve in 2024.

Market Metrics.

When comparing year over year market metrics (aside from equity volume) there are a few items to compare.

	2023	2024
Available Equity	$2,500,412	$2,342,198,682
Number of Programs	93	93
Days on Market	264	317
Number of active Sponsors	51	50
Average 1^st Yr. Return	4.70%	4.94%

There is less equity currently available compared to the end of 2023. The number of overall programs remains the same. Having a variety of asset classes helps investors who seek a replacement property for a 1031 tax deferred exchange. The days on the market have increased which means longer time to sell out a DST asset. The longer time may provide investors with additional options. There has also been an increase in the projected average first year distribution. One item that was not included in the overall summary of the Mountain Dell Report is the number of all cash DST. There continues to be a consistent number of all cash DST (an increase on previous years) as well as reduced LTV (Loan to value) or reduced leverage in the DST offerings. This may not be all good news for investors who need to balance their exchanges with debt. Investors with higher than 60% LTV replacement are most affected.

2024 Equity Invested by Asset Class

Asset Class	Amount Raised	% of Total
Multi Family	$2,133,917,044	37.71
Industrial	$1,668,220,377	29.48%
Retail	$642,299,534	11.35%
Student Housing	$318,215,226	5.62%
Senior Housing	$258,169,846	4.56%
Self-Storage	$173,515,723	3.07%
Hospitality	$121,691,948	2.15%
Office	$193,802,764	1.83%
Office Medical	$89,953,140	1.59%
Other	$72,448,563	1.20%
Manufactured Housing	$8,891,737	0.16%
Total	$5,658,752,034	100%

There is a relationship between the above chart of equity raised and the below chart equity available. It should be clear that because there is more equity available in the Multifamily and Industrial asset class there would be more equity raised. Multifamily and Industrial are still in much demand.

Current Asset Class Metrics

Sponsors have entered a more conservative underwriting reducing the LTV and increasing the equity needed for each DST. Noted in the chart below is average LTV for each asset class. There are no asset classes with an average LTV of over 50%. Understanding that when displaying an average there may be (depending on the asset class) an LTV over 50%. Thus, for investors with a higher LTV need we have a few alternatives. When we assist an investor with a larger §1031 exchange ($1M and above) especially when debt needs to be replaced, we typically blend multiple DSTs with leverage to diversify the replacement portfolio for the investor. Please consult with us for that strategy.

Asset Class	Number of Programs	Available Equity	LTV	Projected Returns
Multi Family	24	$687,265,113	39.34%	4.57%
Industrial	21	$835,839,369	24.24%	4.63%
Retail	20	$293,412,900	16.82%	5.23%
Office	5	$194,839,980	28.68%	5.64%
Senior Housing	3	$161,187,315	16.17%	5.52%
Hospitality	1	$10,975,354	0%	6.01%
Student Housing	4	$132,647,258	38.32%	4.69%
Office/Medical	6	$194,839,261	26.45%	5.01%
Self-Storage	5	$ 37,421,430	0%	4.65%
Energy	1	$6,213,678	0%	9%
Manufactured Housing	0	$0		4%
Other	1	$4,331,000	0%	5%

Final DST Market Overview Comments

If we reflect on the six (6) year average of equity raised prior to 2024 that number was $5.1532 Billion. (See Chart below). In reviewing the numbers 2024 is higher than the 6-year average for equity raised. If you use a 5-year moving average, it was just slightly above. It may take a few years to get close to the record high reach of $9.2 billion in equity raised in 2022 or the $7.2 billion of equity raised in 2021. The underlying demographics for investors wanting to sell actively managed real estate and move into passive ownership could be at an all-time high. We will see if the other market dynamics provide momentum for investors to see their existing properties.

Year	Equity Raised
2018	$2.80B
2019	$3.486B
2020	$3.192B
2021	$7.2B
2022	$9.2B
2023	$5.04B
Six Year Average	$5.153B

We continue to research, review, and monitor all the major DST sponsors. We speak weekly with our sponsor contacts and conduct due diligence on DST offerings. Our continued research enables us to provide a quick response to investor questions regarding their cash investing needs as well as their §1031 tax deferred exchange. We are especially skilled at balancing the exchange debt equity requirements. We also specialize in the §1033 exchange in the case of natural disaster or eminent domain cases. The timeline for investors to decide on their utilization of a §1033 may extend beyond the benchmark 2 years as identified in the §1033 Code and potentially extend to 4 years. With the 2023 hurricanes in Florida and North Carolina as well as the 2024 fires in California, it may be too early to make any prediction on how many investors will take advantage of the §1033 tax advantages. Over the years we have assisted investors in dealing with their emotions as well as their replacement strategy. We are so fortunate in our specific location in Florida dealing with three hurricanes in 2024. Even though the eye of hurricane Milton came over us we were spared damage to our property. Our thoughts and prayers are with the people in southern California at this time.

What to Look for in 2025 and 2026

DSTs have been gaining broader institutional exposure and acceptance. The inclusion of the 721 UPREIT (after a safe harbor period). Large institutional investors have been stepping into the space. Not only on the sponsor level but also the large institutional player and advisors prospective. Schwab and Fidelity have entered the participation via platforming DSTs. Large wire houses are stepping into the 1031 space on the wealth management side of the business. On a different topic, but potentially of vast interest may be the extension of the tax cuts with the new administration as well as a potential modification and extension to the Opportunity Zone (OZ) investment opportunity.

This is not an offer to purchase or solicitation to purchase any security, as such be made only through an offering memorandum or prospectus. Investing in securities, real estate, or any investment, whether public or private, involves risk, including but not limited to the potential of losing some or all of your investment dollars when you invest in securities. You should review any planned financial transactions that may have tax or legal implications with your personal tax or legal advisor. NAMCOA, LLC is a Registered Investment Advisor, regulated by SEC (Securities and Exchange Commission). Our corporate office is located at 999 Vanderbilt Beach Road, Suite 200, Naples Florida 34108. Securities Offered through MSC-BD, LLC, Member of FINRA/SIPC. 8215 SW Tualatin- Sherwood Rd, Suite 200, Tualatin, OR 97062. MSC-BD, LLC and NAMCOA are independently owned and are not affiliated.

Thank you.

§ 721 UPREIT Mission Possible via DST

The term Real Estate Investment Trust (REIT) has been around for a long time. You may trace the roots back to President Eisenhower when legislation was passed by Congress enabling a new style of investing including the attributes of stock base investments and real estate. Acquisition of a REIT is the Mission.

By Al DiNicola, AIF®, CEPA ™
adinicola@namcoa.com
July 12, 2023
DST 1031 Specialist
NAMCOA® – Naples Asset Management Company®, LLC
Securities offered through MSC-BD, LLC

REITs provided an opportunity to invest in high quality real estate with other like-minded (unknown) investors. Over the past 60 plus years the structure and functions of REIT have evolved. There may be a variety of assets or properties that make up the REIT portfolio. REITs may be public or private. Public REITS would trade on the national stock exchange. REITs would be considered passive investments because the portfolio is professionally managed along with requirements of distributions to be made to the investors.

The Mission: Acquiring a REIT

Cash investors may invest directly into a REIT and enjoy the tax advantage that many investors seek. Real estate investors have a few options to participate in a REIT. An individual property owner may contribute their property to a REIT. This is known as a 721 UPREIT. Generally, the contribution investor transfers the real estate property into the REIT (operating partnership) and would receive “units” in return. For the purposes of this writing, we will not discuss the percentage of contribution and the percentage of units an investor may receive in return. Technically the investor is moving from real estate which is considered real property into a REIT which is considered a security. The other option a real estate investor may use to convert their real estate into a REIT would be to enter into a process involving a 1031 tax deferred exchange. You may not utilize a 1031 exchange (directly) into a REIT in one step and immediately. As a reminder the 1031 exchange must be utilized when exchanging like kind property (real property) held for investment or business purposes. REITS falls under the classification of personal property. However, it is possible to move into a REIT in a few steps.

Mission Strategy: DST.

The strategy involves utilizing a Delaware Statutory Trust (DST). DSTs began their popularity starting in 2004. This may be a relatively new strategy for some investors. DSTs in many cases have replaced Tenants in Common (TIC) for fractional ownership. Revenue Ruling 2004-86 (IRS), specifically referenced a DST as a like-kind investment for a 1031 exchange. Investors may utilize the DST as the replacement property via 1031 exchange when selling their investment property. Converting the real estate into a DST moves the investor one step closer to a REIT investment, if that is the ultimate goal.

DSTs offer investors the ability to diversify their real estate holdings into different selected asset classes or geographic locations. The investor would own a beneficial interest in the Trust. The beneficial interest qualifies as a 1031 exchange just like any traditional real estate used as a replacement property in a 1031. The first part of the mission has been accomplished by moving into a DST.

Mission Critical Options

When DSTs are prepared to be sold by the sponsors, the sale may be referenced as a liquidity event. There are typically three exit strategies: simply collect your proceeds and pay capital gains; utilize a 1031 exchange into another DST, and; utilize a 1031 exchange and move back into a traditional real estate holding. Recently a fourth option has been introduced by certain sponsors of DSTs. Some sponsors have affiliations with large institutional REITS that provide investors with the option to move into a REIT utilizing what is known as §721 UPREIT.

Moving the Mission Forward

The second part of the mission would be to move into the REIT. The exact timing of the second part may be somewhat fluid. The ability to move into the REIT will be determined when the liquidity event occurs (also known as the DST going full cycle). Moving into the REIT is a well thought out goal for more than one reason. The liquidity event is determined by the sponsor. There is also what may be referenced as a safe harbor or holding period. Typically, DST sponsors will seek to hold the assets within the individual DST for a period of time. The holding period may be tied to recovering any acquisition cost associated with the structure of the DST. Two to three years may be an adequate period of time in certain situations.

If the investor’s overall mission is to defer capital gains, then the DST does accomplish this and moving into the REIT may provide other solutions as well. This is not intended to be a knee jerk activity.

Mission Review

Here is a review of the mission (if you accept). Investors sell property utilizing a 1031 exchange. The proceeds go to a Qualified Intermediary (QI). The investor identified DST properties (within the required 45-day identification period) and QI funds the acquisition. When the DST is sold in a few years the investor can direct the proceeds into the REIT. The investor will own Operating Partnership Units (OP). What have you gained from your mission? You deferred capital gains on the 1031 exchange into the DST. When you converted into the REIT you paid no taxes on the conversion. As long as you own the REIT you will pay no capital gains taxes. However, you will be responsible for paying any taxes on the income that is distributed from the DST or the REIT based on your personal income tax bracket as well as state of residence. If the end mission is for the REIT to become part of your estate to be passed down your beneficiary will enjoy a step up in basis and not be subjected to any capital gains taxes.

Post Mission Fall Out, If any

You successfully completed your mission of converting your real estate into a 721 UPREIT (via 1031 & DST execution). Once you have moved into a REIT you cannot utilize another 1031 exchange again. Federal and state taxes (if applicable) will be due if you sell your REIT. There is also a safe holding period of 1-2 years to own the OP Units prior to selling. There is an advantage if you were to sell your REIT you may peel off some of your units and not liquidate the entire REIT portfolio. This is not the case with a DST. Some investors seek the added flexibility of the REIT. There is a word of caution as always. Read the Private Placement Memorandum (PPM) or other offering documents and ask questions to your CPA and tax advisors. Over the past few years, the quality of the DST offerings that contain the 721 UPREIT option has increased in offerings.

Suitability

Exercising the 721 UPREIT option is based on individual investor suitability. NAMCOA has additional insight into the DST structure as well as the 721-conversion option. There are benefits to both strategies. If you have questions, please contact us.

DSTs are not for all investors.

The acquisition of a DST is for accredited investors only. Contact your investment adviser for additional details on how a DST may be a solution to your 1031 Exchange and suited for your investment future. For more information on how to properly set up an IRC 1031Tax Deferred Exchange or if you are an accredited investor and would like additional information on a DST contact Al DiNicola at 239-691-8098 or email adinicola@namcoa.com.

This is not an offer to purchase or solicitation to purchase any security, as such be made only through an offering memorandum or prospectus. Investing in securities, real estate, or any investment, whether public or private, involves risk, including but not limited to the potential of losing some or all of your investment dollars when you invest in securities. You should review any planned financial transactions that may have tax or legal implications with your personal tax or legal advisor. NAMCOA, LLC is a Registered Investment Advisor, regulated by SEC (Securities and Exchange Commission). Our corporate office is located at 999 Vanderbilt Beach Road, Suite 200, Naples Florida 34108. Securities Offered through MSC-BD, LLC, Member of FINRA/SIPC. 8215 SW Tualatin -Sherwood Rd, Suite 200 Tualatin, OR 97062. MSC-BD, LLC and NAMCOA are independently owned and are not affiliated.

SOCIAL MEDIA

Social Media platforms are solely for informational purposes. Advisory services are only offered to clients or prospective clients where the advisory firm and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by NAMCOA unless a client service agreement is in place.

Thank you.

“Pro et Contra” Partial 1031 Exchange

“Pro et Contra” From Latin “Pro et Contra” typically translates to “Pros” and “Cons”. Basically meaning arguments for, or against a particular issue. When entering or exiting a partial 1031 tax deferred exchange (either by design or accident) there are pros and cons.

By Al DiNicola, AIF®, CEPA ™
adinicola@namcoa.com
July 7, 2023
DST 1031 Specialist
NAMCOA® – Naples Asset Management Company®, LLC
Securities offered through MSC-BD, LLC

There may be three reasons why a partial exchange occurred. The reasons may be by design; one or more of your identified properties became unavailable for some reason, or; the final negotiated price on your replacement properties did not use all the cash.

Intentional or Unintentional

If entering a partial exchange by design, the real estate investor may be seeking to access cash tied up in the real estate for a variety of purposes. The funds may be used to take a vacation, business funding, pay for a child’s college or wedding or other reasons. When you sell your property via a 1031 tax deferred exchange it is possible (by design) to retain a portion of the funds. The other two reasons, where you receive cash, may have occurred unintentionally.

There are a variety of reasons why all the cash may not be used in a 1031 exchange. If only a portion of the cash is used in the exchange, then that portion would enjoy the tax deferral. Retaining a portion of the proceeds is considered a partial exchange. Partial exchanges happen every day. The proceeds not invested in a 1031 exchange is considered “boot” and subject to capital gain taxes. There is also another type of tax that would be due and that would be the recapture of depreciation taken on the property. There may also be another type of boot called mortgage boot. That is another topic for discussion.

Partial Exchange Review

The IRS has very strict rules, guidelines, timing as well as other regulations regarding successfully executing a 1031 tax deferred exchange. The planned partial exchange happens when an investor knows specifically, they want to retain proceeds from the exchange after the replacement property is acquired. Other partial exchanges may occur when investors may have identified multiple properties on their list and find out after the 45-day period has expired that one of the properties they intended to purchase is no longer available. Yet another partial exchange may occur when investors negotiate a price on the replacement property (lower than the required market replacement value) and have proceeds left over.

First things first.

We cannot emphasize enough the importance of the Qualified Intermediary (QI) holding the proceeds of sale of your relinquished property. After an investor closes on the relinquished property and enters the 45-day identification period, there are a lot of unknowns as to the actual cost of the replacement property. Once the final negotiated price has been established and all closing cost have been estimated the investor should have a good idea on the excess proceeds that may be available. The investor may have designed for cash to be left over. If the cash left over is not by design, then a Delaware Statutory Trust (DST) may provide a solution.

Receiving your Funds

So when can you receive the excess funds from the QI? Actually, it depends. It depends on a few items that may or may not have been included on your 45-day list. We will elaborate but in either case as soon as you receive the proceeds, you are liable for paying taxes on the process you receive.

Why does it depend on how you filled out the 45-day form? If you have only placed one property on the form and successfully closed on the one property, then on the 46^th day the QI will return your excess proceeds. However, if you have placed 2or 3 properties on the form and only closed on one property, then the QI is required to hold your funds for the 180 days and return on the 181^st day.

Stepping back to understand

Here is an example of how the partial exchange may work. You just sold a property for $700,000 and there was no mortgage on the property. The new property costs $500,000. If you only close on the one property, and retain $200,000, you will be taxed at your ordinary tax rate. The $200,000 that is not reinvested into the replacement property is called boot. Under the 1031 regulations the replacement property must be equal to or greater than the relinquished property.

Are there positives to a Partial 1031 Exchange?

One positive of the partial exchange is the ability to access your cash that was tied up in the real estate. Access to cash may be needed for an emergency and once cash is received the investor may use the cash for any reason. Again, the cash is subject to tax. DSTs have provided a viable solution for left over cash or as a back up to replacement properties that cannot be acquired.

DSTs also offer a potential solution when failing to replace leverage and debt. A question often arises from investors who sell a property that has debt but wants to eliminate future recourse debt. Here is an example. The investor is selling a property for $700,000 and has a remaining loan on the property in the amount of $100,000. The investor locates a property for $600,000. The investor is avoiding applying for and being responsible for debt in the amount to $100,000. The $100,000 loan that was paid off (and not replaced) would be considered mortgage boot and subjected to being taxed. By structure many DST come prepackaged with non-recourse debt. Each DST will have their own loan to value (LTV) and there are additional DST alternatives that may provide a solution to provide a tax free (deferred tax) complete exchange. DSTs have been a viable alternative for boot.

“Contra” The Drawbacks utilizing a Partial 1031 Exchange

The biggest drawback would be the requirement to pay taxes on the cash boot or the mortgage boot.

Additional Comments.

Executing a partial exchange is an acceptable alternative to a typical 1031 tax deferred exchange. Understanding your individual situation is most important. If an investor needs access to cash tied up in the real estate for other financial needs this may be the prudent course of action. We have assisted investors explore the partial exchange as well as execute the partial exchange. We have assisted investors who have sold a property they have owned for thirty years. Over the time of ownership, the entire mortgage has been paid off and now they have no debt. In addition, the property represented close to 100% of their assets besides their primary residence. The investor has grown tired of dealing with the tenants (toilets & trash) as well as active management. The DST may provide a great solution for a passive investment. There are a few words of caution. DSTs are considered an ill-liquid investment and do not provide an opportunity to tap into for accessing cash. You may also not be able to utilize a DST as collateral to borrow against. The partial exchange may provide you with access to cash albeit you will pay tax on the cash not reinvested but retained.

Please consult your CPA or tax advisor to discuss your individual solution. .

DSTs are not for all investors. The acquisition of a DST is for accredited investors only. Contact your investment adviser for additional details on how a DST may be a solution to your 1031 Exchange and suited for your investment future. For more information on how to properly set up an IRC 1031Tax Deferred Exchange or if you are an accredited investor and would like additional information on a DST contact Al DiNicola at 239-691-8098 or email adinicola@namcoa.com.

This is not an offer to purchase or solicitation to purchase any security, as such be made only through an offering memorandum or prospectus. Investing in securities, real estate, or any investment, whether public or private, involves risk, including but not limited to the potential of losing some or all of your investment dollars when you invest in securities. You should review any planned financial transactions that may have tax or legal implications with your personal tax or legal advisor. NAMCOA, LLC is a Registered Investment Advisor, regulated by SEC (Securities and Exchange Commission). Our corporate office is located at 999 Vanderbilt Beach Road, Suite 200, Naples Florida 34108. Securities Offered through MSC-BD, LLC, Member of FINRA/SIPC. 8215 SW Tualatin -Sherwood Rd, Suite 200 Tualatin, OR 97062. MSC-BD, LLC and NAMCOA are independently owned and are not affiliated.

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1031 Cash Investors May Benefit when Investing in Leveraged DST

Investors who are entering into a 1031 tax deferred exchange may wonder, what are the benefits of taking on additional debt, meaning adding leverage to their replacement purchase. Leverage has been considered a method of increasing the real estate being purchased.

By Al DiNicola, AIF®, CEPA ™
adinicola@namcoa.com
June 13, 2023
DST 1031 Specialist
NAMCOA® – Naples Asset Management Company®, LLC
Securities offered through MSC-BD, LLC

In simple terms $100,000 invested with cash may control a property worth $100,000. Investors will acknowledge there may be appreciation on the property. If the same investor used the $100,000 and obtained a mortgage for $100,000 the investor may control a property worth $200,000. If over time each investment increased 10% the $200,000 property would be of greater overall value. Granted there is the necessary compliance with banking and lending requirements, credit checks, and time to secure the funding.

DST as an alternative.

Utilizing a 1031 Delaware Statutory Trust (DST)exchange may provide an alternative to consider. The first requirement on acquiring a DST (either utilizing cash or cash from a 1031 exchange) is the investor/exchanger needs to be an accredited investor. There are two methods to be considered an accredited investor. You either qualify on net worth ($1M in assets not including your primary residence) or income over the past few years ($200,000 if single or $300,000 if a couple).

To manage or not to manage, that is the question.

In most typical real estate ownership, the investor actively manages the property (or could hire a property management team). The investor in a DST is passive meaning there is no active management on the part of the investor. The DST property is professionally managed under the terms of a master lease. The DST is a form of fractional ownership that is established by a sponsor. Typically, a large real estate corporation. One of the first investor decisions to be made may be: do I want to actively manage the replacement property or have a separate organization handle. Depending on the age and goals of the investors passive ownership and passive income may sound better than dealing with the day-to-day operations of a real estate investment.

For investors who have owned their property for an extended period of time, utilized leverage and you may have paid off the mortgage on your property. Congratulations. There are investors who have acquired their investment property with all cash (with out leverage). Also, Congratulation. Regardless of how you have arrived at your real estate being debt free you may want to consider moving into a leveraged DST via a 1031 exchange.

We encourage investors to start their DST educational process as soon as possible. Once investors have entered their 45-day identification period there will be opportunities to focus in on the correct alternative. The focus may be on the asset class, geographic location or both.

Leverage up your acquisition power.

Acquiring a DST with non-recourse leverage may increase the value of the real estate you are purchasing. Here is an example. If you sold a property for $400,000 and purchased another property for $400,000 your baseline for appreciation is $400,000. If you utilize the non-recourse debt feature of the DST and acquire a property with a 50% Loan to Value (LTV) you would be acquiring $800,000 worth of real estate.

Diversification advantages.

One of the features of the DST is your ability to invest in multiple properties or in multiple geographic areas. Many DST offerings require a minimum investment of $100,000. Technically your $400,000 could acquire interests in four (4) different DSTs. It may be extremely difficult to find four traditional properties for the $400,000.

Passive Income is good income.

DSTs are not designed for an investor who wants to be a hands-on investor and review leases, take care of repairs and all the other responsibilities of active management. This is a passive investment that generates passive income. The properties are professionally managed under a master lease. On-site management working with the DST sponsor keeps the properties in top condition and provides ongoing reports and updates.

Increase Tax Efficiency:

Depending on how long investors have owned their property there will or may be a limited amount of carried forward basis providing depreciation on the asset for tax efficiencies. Adding a DST that has leverage adds to the basis and may also provide tax efficiencies by offsetting income with tax-deductible interest paid on the debt used to acquire the property. Even though the debt is non-recourse, investors enjoy their share of applicable write offs. As with all 1031 tax deferred exchanges utilizing a DST as a replacement property enables investors to defer capital gains. We are not providing tax advise and suggest investors contact their own tax professional.

Where are DSTs located?

DSTs are located in almost every state. Some investors may want to own real estate in a specific region or state in the country. A few states have some added restrictions on 1031 which may or not qualify for deferral of state income tax.

The question of state taxes does come up frequently. Actually, there are two questions.

If using a 1031 tax deferred exchange, do I defer Federal as well as state taxes.
Do I need to pay income on the income being generated by my passive investment.

As to the first question, there are four states that have a provision known as a claw back provision. Massachusetts, Montana, Oregon, and California have slightly different claw back provisions. As to the second question, there are DSTs located in tax free states (such as Texas, Tennessee, Florida, etc.) that do not require you to file in that specific state. However, investors are responsible for reporting the income received on their tax filings. If residing in a state with a state income tax, there may be another long-term consideration. We have investors who currently live in a state that has a state income tax. If the investor is considering moving to a tax-free state, that may be taken into consideration which DST to acquire.

Summary:

There are numerous benefits for investing in a leveraged DST depending on your individual situation. There may be increased acquisition advantages of buying more property. This would add to diversification. Diversification does not eliminate all risks. DSTs also provides professional management, passive income, and potential distributions. There is a word of caution regarding acquiring debt. If the investor enters into another future exchange that debt would need to be replaced. The only time the debt would not need to be replaced would be in the case of a step up in basis created by the passing of the investors. Contact us for additional information on the DST structure and function for your potential investment solutions.

This is not an offer to purchase or solicitation to purchase any security, as such be made only through an offering memorandum or prospectus. Investing in securities, real estate, or any investment, whether public or private, involves risk, including but not limited to the potential of losing some or all of your investment dollars when you invest in securities. You should review any planned financial transactions that may have tax or legal implications with your personal tax or legal advisor. NAMCOA, LLC is a Registered Investment Advisor, regulated by SEC (Securities and Exchange Commission). Our corporate office is located at 999 Vanderbilt Beach Road, Suite 200, Naples Florida 34108. Securities Offered through MSC-BD, LLC, Member of FINRA/SIPC. 8215 SW Tualatin -Sherwood Rd, Suite 200 Tualatin, OR 97062. MSC-BD, LLC and NAMCOA are independently owned and are not affiliated.

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NAMCOA® – Naples Asset Management Company®, LLC

Understanding §1031 Tax Deferred Exchange Identification Rules

Occasionally we receive a frantic call from an investor who is in the middle (sometimes at the end) of their 45-day identification period. Understanding the identification rules prior to entering a potential exchange may be the preferred path.

By Al DiNicola, AIF®, CEPA ™
adinicola@namcoa.com
June 9, 2023
DST 1031 Specialist
NAMCOA® – Naples Asset Management Company®, LLC
Securities offered through MSC-BD, LLC

The 1031 clock starts ticking upon the closing of the relinquished property. The 45 days are calendar days and no matter what day of the week the 45^th day falls the identification period ends. Even if the 45^th day is a weekend or holiday.

The investor (along with a financial advisor, real estate broker or other parties) will start evaluating potential replacement properties during the 45 days. One point to make clear is that during the 45 days the investor may change the properties on the 45-day list. Changes may be necessary especially if the intended replacement property is no longer suitable for the investor, is acquired by other investors or under other circumstances.

Without a QI, nothing else matters.

The qualified intermediary (QI) is a critical player in the exchange process. We cannot stress enough the importance of engaging a QI as soon as the investor has decided to sell the property referenced as the relinquished property. If the investor has sold the property without a QI being part of the transaction the exchange cannot be executed. Even if the title company is holding the sales proceeds in their escrow account. We would also strongly encourage language in the sales contract (of the relinquished property) to reflect the seller intends on executing a 1031 tax deferred exchange and the buyer shall not object to the process. Once the property is sold and the QI has received the proceeds of the sale the QI typically will send a form to the investor to fill out and send back to the QI. The IRS requires this form to be submitted to ensure that properties ultimately acquired were reflected on the form.

Identify by putting it in writing.

There are specific requirements set out in section 1031 regarding the acknowledgment or commitment to a certain list of potential replacement properties. The investor is referred to as the Exchanger and is required to submit a signed document to the QI. The QI is handling the details of the exchange sale. There are different acceptable methods of submitting the list to the QI. Some Exchangers may hand deliver the list. Other Exchangers will use email or fax to send the list. A text message is not a preferred method of communication. This list must be received by the QI by the end of the 45^th day. We have worked with Exchangers who engaged with a QI on the west coast and have pushed the envelope so to speak with submissions. Best practices would encourage the Exchanger to have the final 45-day list submitted so that the QI may acknowledge receipt of the document.

If there is a change in the makeup of the list, we strongly encourage the Exchanger to send the new list with a notation that this current list supersedes or voids any previous list submitted on a previous date and list the previous document date. If there are a number of changes during the 45-days, the exchanger may want to title the list with a version number (v.1. v.2) and when the ultimate list is submitted mark the list FINAL.

ID Details matter.

Depending on the property the identification may be very easy or complicated. In the case of a single property there may be only one address and a tax identification number supplied by the property appraiser office. When purchasing land as a replacement property the legal descriptions may be more involved and have meets and bounds description. Clarity is the key for the identification. In the case of fractional ownership such as Tenants in Common (TIC) or a Delaware Statutory Trust (DST) many QIs (and the IRS) would prefer to have a percentage of ownership especially if not purchasing the entire property. Even in a partnership interest a full description and percentage of ownership is required to eliminate any confusion or challenge if there is an IRS audit on the exchange.

Reviewing the financial requirements

As a brief review of the financial requirements the Exchanger needs to :

Replace the relinquished property with equal or greater value
Replace any debt that was paid off on the relinquished property.
Use all the cash the QI is holding.

Let’s review the rules for identifying properties.

The first rule (and potentially most often used) is the Three Property Rule.

This may be the simplest of the rules for filling out the list. You may identify three properties no matter what the fair market value may be. For example, if your relinquished property was sold for $500,000 you may identify three properties with a total value of $1,500,000.

If you have identified three properties that were less than the replacement price you may acquire more than one property. If buying only one property, the other identified property will be back-ups if for some reason the first property falls through.

Potential greater flexibility with the 200% Rule

The 200% rule can be confusing at times when attempting to calculate the values. In simple terms you may identify as many properties as you want, as long as the total value does not exceed 200% of the fair market value of your relinquished property. What complicates this to a certain degree would be that the identified properties will include the total acquisition price including any debt that is being replaced. If we use the same $500,000 in the example above and if it is an all-cash transaction you may list as many properties as you want up to a total of $1 M. If you are financing part of the replacement properties, you will need to evaluate the specific LTVs on each property and then identify as a total price.

Seldom used 95% Identification Rule

In all our years of dealing with 1031 exchanges (including DST replacement) we have not seen any investor utilize the 95% Rule. This enables an investor to identify as many properties as they wish regardless of value, as long as they purchase 95% of all properties identified. Anything less would jeopardize the exchange.

Next steps

The first step to a successful exchange may start with hiring the right Qualified intermediary (or accommodator). While the cost may vary a few hundred dollars, you want an experienced QI. Understanding your replacement options prior to entering into an exchange is an important step. Each of the rules has positives and drawbacks.

DST Flexibility.

Delaware Statutory Trust (DST) has provided a solution for many investors who become exchangers. The DST options provide for diversification of replacement properties and can satisfy debt replacement with non-recourse debt. There is also flexibility in balancing the debt with certain DST properties enabling the exchanger to potentially spread risk out over a diversified portfolio of properties. The same $500,000 property example from above may enable an investor to invest in a DST portfolio of three to four properties with different asset classes as well as geographic diversification.

Final thought.

We opened this article with a frantic call from investors who were in the middle or end of their 45-day identification period. We have successfully assisted investor/exchanger who had only two days remaining in their identification period. While this is not the preferred timing, we have access to a wide variety of DST replacement properties. Investor who have spent time reviewing the DST alternative can make a decision on moving forward.

This is not an offer to purchase or solicitation to purchase any security, as such be made only through an offering memorandum or prospectus. Investing in securities, real estate, or any investment, whether public or private, involves risk, including but not limited to the potential of losing some or all of your investment dollars when you invest in securities. You should review any planned financial transactions that may have tax or legal implications with your personal tax or legal advisor. NAMCOA, LLC is a Registered Investment Advisor, regulated by SEC (Securities and Exchange Commission). Our corporate office is located at 999 Vanderbilt Beach Road, Suite 200, Naples Florida 34108. Securities Offered through MSC-BD, LLC, Member of FINRA/SIPC. 8215 SW Tualatin -Sherwood Rd, Suite 200 Tualatin, OR 97062. MSC-BD, LLC and NAMCOA are independently owned and are not affiliated.

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NAMCOA® – Naples Asset Management Company®, LLC

Common §1031 Mistakes and Misconceptions

Learning from History and Experience. Over my 40-year career as a real estate broker and an investment advisor I have seen countless 1031 exchanges. The IRC §1031 exchange is a tool that has been used by investors for over 100 years in the US to defer capital gains, realign assets, create generational wealth and accomplish other goals.

By Al DiNicola, AIF®, CEPA ™
adinicola@namcoa.com
June 4, 2023
DST 1031 Specialist
NAMCOA® – Naples Asset Management Company®, LLC
Securities offered through MSC-BD, LLC

We have been fortunate to work with many investors who stayed on track with all the IRC §1031 requirements to successfully complete the exchange and defer capital gain taxes. We have also been able to guide investors into Delaware Statutory Trust (DSTs) that qualify for the 1031 exchange program and provide passive tax favored income. Along the way we have witnessed successful exchanges. Successful exchanges may get more attention than the exchanges that do not go well. We study history to learn from other’s mistakes. Albeit occasionally some investors may repeat the mistakes of others. We will attempt to review the biggest faux pas that will sink or blow up an exchange.

There are about ten situations that may turn into mistakes that we will outline and briefly comment on in this article.

Failing to create a plan. Over the recurring cycles of real estate, investors will watch the value of their investment rise and decide to sell their investment. Excited real estate brokers & agents are ready, willing, and able to list the property, especially in a fluid market. Occasionally the investment property sells quickly, and the investor has not properly planned what the exit strategy is for the proceeds. Is the plan to pay the capital gains and move on or utilize the 1031 tax deferred exchange alternative. Exit planning is simply good business.
The parties who assist you in setting up your exchange are critical. Simply using a real estate attorney does not guarantee success especially if the real estate attorney is not proficient in 1031 exchange process. Although you’re exchanging real estate, a 1031 exchange is a tax transaction as much as a real estate transaction, if not more so. If a 1031 exchange is not done properly, the tax consequences can be significant. The exchange company (referenced as a qualified intermediary or QI) should understand how to comply with the IRC 1031 exchange rules. Occasionally an investor will deposit their sales proceeds with an escrow agent or take constructive receipt of the proceeds rather than having the proceeds from the relinquished property placed with a QI. This will void the 1031 exchange. Proceeds must be held by a QI. Attorneys must also be set up as a QI if they are handling the exchange.
There are many reputable QIs. Every day QIs effectively complete the exchanges for investors. There are no licensing requirements to be a QI. This is an unregulated profession if compared to a real estate license or investment advisors licensing requirements. There are professional organizations of QI who sponsor best practices and professional standards. However, if you use a QI without asking the right questions there may be a potential of the exchange not going well or worse yet losing your funds. Your due diligence questions may include how your funds will be deposited and if a separate account is used for your funds. Also check out the process for the release of your funds.
Overpaying for the replacement property. Once you enter a 1031 exchange (with a QI) a big mistake is targeting your replacement property with spending all the proceeds being held by the QI. There are three elements when deciding on the replacement property. How to locate, how to negotiate and how not to overpay. Typically, sellers will know the investor is a 1031 investor based on contract language as well as real estate agent feedback. The listing broker on the replacement property as well as the seller may be reluctant to negotiate. The 1031 investor may simply want to spend all the cash. There have been studies that have shown 1031 investors may be paying 15% more for the replacement properties simply because to avoid capital gain taxes, the investor needs to spend all the cash.
Buying anything that comes along. An investor may pull the trigger and sell their investment property and turn around and buy something that may not make sense. A hasty purchase with additional capital improvements may create investor remorse and wishing they had not sold their property in the first place.
Understanding the numbers. You don’t need to be a rocket scientist to execute a 1031 exchange, but you do need to watch the details. Understanding the numbers on the cost of selling the property and acquiring the replacement property is critical to understand. Understanding the debt that may need to be replaced is also an important component. Taxable events can be avoided by ensuring the total understanding of all required cost items.
1031 exchanges are Deferral not Elimination of taxes. Capital gains taxes can be deferred to a later time but are not eliminated for the investor. Capital gains taxes are typically less than ordinary income tax. There would be the elimination of taxes would happen if the investors retained the property and pass the property to their heirs. This is known as a step up in basis upon the death of the investor.
The clock is ticking. The 45-day clock starts ticking when the investor is closing on the relinquished property. Many times, 45-days seems like a long time. However, when you add in contract negotiation, inspections, loan approval (if needed) and other potential issues all compound the challenge. At the end of the 45-day period an investor may simply purchase something, anything, just to complete the 1031 exchange.
This is tax planning. Tax planning for investment real estate is very important to provide the most efficient utilization of the tax codes. Investors need to understand depreciation, carry forward depreciation as well as other potential real estate write offs.
Cash boot and mortgage boot. There is a double-edged sword with negotiating a better price and not using all the cash. You paid less for the property but need to pay capital gains on the cash you did not use. Likewise, if you paid off a loan and you cannot arrange non-recourse financing this would be mortgage boot and taxable. This may result in your total replacement price falling short.

There is a potential DST solution for many of the issues. Accredited investors seeking replacement properties with a passive investment will seek Delaware Statutory Trust (DST). The advantage with the DST structure affords the investor with non-recourse debt on the prepackage investment alternatives.

Leftover proceeds from strong negotiations may be invested into a DST. Proceeds as little as $100,000 may be placed in a DST avoiding capital gains.

This is not an offer to purchase or solicitation to purchase any security, as such be made only through an offering memorandum or prospectus. Investing in securities, real estate, or any investment, whether public or private, involves risk, including but not limited to the potential of losing some or all of your investment dollars when you invest in securities. You should review any planned financial transactions that may have tax or legal implications with your personal tax or legal advisor. NAMCOA, LLC is a Registered Investment Advisor, regulated by SEC (Securities and Exchange Commission). Our corporate office is located at 999 Vanderbilt Beach Road, Suite 200, Naples Florida 34108. Securities Offered through MSC-BD, LLC, Member of FINRA/SIPC. 8215 SW Tualatin -Sherwood Rd, Suite 200 Tualatin, OR 97062. MSC-BD, LLC and NAMCOA are independently owned and are not affiliated.

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Evaluating the DST Sponsor

We have written many articles on the types of Delaware Statutory Trust (DST), the due diligence process we engage as well as advising on the best alternative for each individual accredited investor. We track our compliance requirements prior to investors engaging with a DST Sponsor. There is one question that we have not addressed in a few years. That question is how we (and you as an investor) evaluate the DST Sponsor.

UPDATED: April 28, 2023
Original Release: August 2019
By Al DiNicola, AIF®, CEPA ™
adinicola@namcoa.com
DST 1031 Specialist
NAMCOA® – Naples Asset Management Company®, LLC
Securities offered through MSC-BD, LLC

One of the first areas of consideration would be to identify the sponsors who would be offering the different DSTs as either a direct cash investment or replacement property for a 1031 tax deferred exchange. The landscape of available DST properties has changed over the past 2-3 years. The number of properties that were available prior to, during, and post COVID is an interesting analysis. As we came out of COVID there was a pent-up demand for 1031 replacement properties and a limited supply. This placed additional pressure on everyone involved in the DST “pipeline” or “supply Chain”. Fortunately, we are in a position where the investor has more opportunity to investigate the alternatives that are available. These alternatives are created by Sponsors.

What is the role of the Sponsor?

The Delaware Statutory Trust is formed under Delaware laws. This is set up for the purpose of conducting real estate business. This is considered a specialized type of investment entity. The entity or party setting up the DST is referred to as the sponsor.

The sponsor creates the trust, finds the property to be acquired, utilizing specialized attorneys to create the Private Placement Memorandum (PPM), and structures the management of the property once acquired. The sponsor also seeks to raise the necessary capital. The capital is raised mostly through financial advisors and representatives. Many times, the capital is raised through independent representatives and not a direct employee or associate with the sponsor. We will cover that aspect a little later.

The role of the sponsor is critical as they hold a key component in the successful launch, management, and eventual disposition of the property. Many times, you will hear the word asset class associated with the property. Asset class refers to the type of property. This may be multifamily, student housing, senior housing, build for rent, industrial, manufactured housing, self-storage, medical office, necessary retail, life science. These assets are institutional grade properties and typically out of the reach of many individual investors. The sponsor will be in charge of the offering and often be in control of and protect the DST so to speak. Their supervision is one of the key elements of success.

Preparing the offering

There are many critical steps sponsors need to take in order to prepare and present the offering to the individual investors. The sponsor will focus on the property that will be acquired and then packaged structurally as well as functionally. The DST needs to be prepared with documentation to be submitted to the SEC and FINRA. Attorneys need to prepare the Private Placement Memorandum (PPM) as well as a review of the offering by a third-party evaluation firm. Firms such as Fact Right, Mick Law, Bowman and others review the offerings. The review is a non-biased evaluation of the offering and comparison to other current and past offerings.

Independent advisors, registered investments advisors and broker/dealer representatives will review offerings that sponsors bring to market. Some advisors will meet and establish a line of communication with the sponsor to have access to all the background on the asset. Some firms require their representatives to complete due diligence and compliance reviews prior to interacting with individual investors. We review new DST offerings every week and hundreds over the past few years. Not every DST is suitable for every investor. Suitability and timing are key in the selection of the DST for the investor.

Does the Sponsor Matter?

Over the past 20 years, with DST being approved as a viable option for a 1031 exchange replacement property, there has been an increase in the number of Sponsors. Each sponsor is independent and may have a different approach to their offerings. Some sponsors will only focus on a specific asset class such as necessary retail or multifamily offerings. The size and level of sophistication will differ. The track record of the sponsor will also be different. Many of the new sponsors have long histories in the financial sector such as Real Estate Investment Trust (REIT) sponsors. The transition to DST offerings becomes another product offering for REIT sponsors. As a note, REITs do not qualify for 1031 tax deferred exchanges. However, the track record of the sponsor is important to consider.

Communication is important between the sponsor and the investor. It is difficult for the investor to gauge the level of expected communication and actual communication they will have with the sponsor. This is where the independent advisor may be of value. Independent advisors who have previous investors and relationships with sponsors can shed light on the ongoing communication that new investors will experience. Communication of important end of year tax document becomes top of mind as a must have for the investor. These documents need to be delivered on time to avoid any tax filing extensions for the investors.

How are sponsors established or organized?

It may be a little confusing at first trying to evaluate who is offering the DST. There are many private equity firms raising funds for a variety of real estate offerings and other alternative real estate investments. How a DST sponsor may be like and unlike a Private Equity Firm may be unclear.

Entities that invest money (equity) in other companies and potentially their own real estate are referenced as private equity firms. There may be an offering of a DST by the private equity firms. If that is the case the private equity firm will be the investment sponsor.

On the flip side the DST sponsor could be a private equity firm but does not need to be. This has more to do with structure than function. The DST sponsor’s organizational structure is different but still enables the DST sponsor to create offerings. Many of the individuals within the DST sponsors firm have years of experience in real estate, finance, and operations they bring to the firm.

DST Sponsor Credentials

When evaluating the DST investment options the review of the sponsor credentials or pedigree is one the most important factors

Experience: The sponsors of DSTs who have a background in commercial real estate have a propensity for a better outcome than new comers to the commercial real estate arena. Large institutional REITs may be entering the DST marketplace and they bring decades of experience.
Size: The overall size of the sponsor of the DST is very interesting. Some of the older sponsors are smaller firms who specialize in a very targeted asset class. Other sponsors are very large organizations handling multiple classes of offerings. Some investors may seek out larger firms simply based on the size of the company. There are very experienced companies who are laser focused on a smaller number of offerings each year. Larger sponsors may have 30-40 offerings in a year while smaller sponsors may have 5-10 offerings. Advisors who perform due diligence on the individual sponsors have insight into the overall competency of the sponsor. Finding the best DST that is suitable for the individual investor is most important.
Asset Class: The same asset classes that exist in commercial real estate exist in DST offerings. Some sponsors of DST may be focused on a single asset class such as self-storage or multi family. Other sponsors may have a variety of asset classes in their offering menu.
Cost: There are costs associated with establishing the DST and Sponsors charge fees. The amount of fees may vary by sponsor but typically the range is minimal from an overall cost structure. The costs in DST are packaged within the offerings meaning individual investors do not come out of pocket for additional fees on top of their investment. Costs and fees are fully disclosed in the PPM. Part of investor due diligence should include comparison of costs and fees between sponsors. You may hear the reference to the “load” on the offering. The load would be all of the cost of establishing the offerings that is added to the acquisition of the property. This may be compared to buying a regular real estate property where the closing cost on the property, points on the loan, title insurance, as well as commission paid (by the seller) are included in the overall cost of buying real estate.

We interface with all of the major sponsors and evaluate the newer sponsors entering the market place. Some of the more active sponsors are Inland, Capital Square, Passco, Exchange Right, Versity, Madison Capital, Cove Capital, Carter, NexPoint, Cantor-Fitzgerald and there are others we review and assist investors with their acquisitions.

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What are the Basics for Calculating Your Basis

When an investor sells an investment property there is the ability to defer paying capital gains taxes (taxed at 0%, 15%, or 20%) as well as the recapture of depreciation (taxed at 25%) for payment at another time. The IRC §1031 enables you to exchange the property you are selling for another property.

By Al DiNicola, AIF®, CEPA™
April 20, 2023
Adinicola@namcoa.com
DST 1031 Specialist
NAMCOA® – Naples Asset Management Company®, LLC
Securities offered through MSC-BD

This may be referred to as a like kind exchange. For the purposes of this writing, we will address investment property and not primary residential property. We are not providing tax advice and investors are encouraged to consult their own CPA.

Understanding basis in a 1031 exchange.

There are several types of basis, including:

Original Cost basis;
Adjusted Cost Basis;
Depreciated Basis;
Tax Basis;
Carried Forward Basis; and
Step up in Basis.

The confusion may begin with an investor wondering what happens to their basis when the property is sold. When the topic of depreciation arises there are a variety of questions. What happens to depreciation while I own the property? How long does it take to use up all the depreciation? How can I start depreciation over again with a new property? If I use up all the depreciation and I still want tax advantaged real estate, what do I do? Does the entire property get depreciated? All of these questions and more may be traced back to the original property to establish your basis. There may be a long paper trail needed if you do multiple exchanges.

Hypothetical example

Jack & Diane are selling a rental house in New Jersey. They paid $175,000 for the property in January 2002. They also paid 15,000 in closing costs. They invested another $25,000 to add a garage. They accept an offer for $400,000 on the property (December closing 2022). They have owned the property for ten years. They have located a property in Daytona Beach for $400,000.

Original Cost Basis

The original cost basis is the original purchase price, associated closing cost at the time of acquisition of the relinquished property. The original cost basis in the home would be $190,000 ($175,000 original purchase price, $15,000 in closing cost).

Adjusted Basis

The adjusted basis would be the original cost basis plus the $25,000 for the garage. If there were any other major renovation or cost that adds to the value of the home those cost or investment would be added. For this example, the total adjusted cost basis would be $215,000.

Depreciated Basis

Depreciation is an interesting situation. The IRS assumes you have taken the depreciation whether you utilized that depreciation or not. The property was depreciated each year. The depreciation schedule is 27.5 years for residential property (commercial property is 39 years). However, the entire purchase price of $175,000 is not depreciated. Only the structure can be depreciated and not the land. For this example, we will assign a land value of $25,000 to the property and $150,000 for the structure plus the closing cost of $15,000 and addition of the garage $25,000 for a total of $190,000. The depreciation taken was $6,900 each year for a total of $138,000. In this case the property has a depreciated basis of $77,000. In some cases, the depreciated basis may be zero if the property was held for the entire depreciation period.

Original Purchase	$175,000
Closing Cost	$15,000
Original Cost Basis	$190,000
Garage Addition	$25,000
Adjusted Cost Basis	$215,000

Depreciation taken (rounded)	$138,000
Depreciated Basis (rounded)	$77,000

Tax Basis

One of the first items an investor may want to know is the tax basis in order to determine if the investor wishes to enter into a 1031 tax deferred exchange. The tax basis would be used to establish the capital gains on the property as well as the recapture of the depreciation over the years. The New Jersey home has an adjusted cost basis of $215,000 and sold for $400,000. The cost of selling the New Jersey home was $20,000 and that is subtracted from the selling price to arrive at the net selling price used to determine the capital gains. This would be $380,000. The net selling price on the property would be $380,000 minus the $77,000 depreciated basis taken for a Tax Basis of $303,000. For federal tax purposes this amount is divided into recapture and capital gains. There will be recapture of the $138,000 depreciation taken is taxed at a rate of 25%. The remaining $165,000 would be taxed at the capital gains rate. This would depend on the individual tax payer (0%, 15%, 20%). Individual states such as New Jersey have taxes that are also due upon the sale and would use the entire $303,000 for calculations. There may also be (depending on tax payer income level) a 3.8% NIC tax on gain. These taxes would be deferred if utilizing a 1031 tax deferred exchange.

Carry Forward Basis

The $77,000 depreciated basis is the carried forward basis. The property in Daytona Beach is the same price as the New Jersey home being sold. This is a very important fact because the price of the new property is a big factor that affects many items. Actually, they are buying equal. Because they bought equal the basis in the new property is the same as the remaining basis in the New Jersey home. The basis rolls forward to the new Daytona Beach property.

The original date (2002) of the New Jersey home is what appears on the future depreciation schedules. The depreciation schedule carries over as if they were still depreciating the New Jersey home. In this case there is no additional depreciation time other than what is remaining on the $77,000. That would be seven- and one-half years remaining.

If you had a mortgage on the relinquished property this will be noted.

The depreciated basis on an investment property can appear to be allusive to determine. One of the most important factors is the purchase price of the replacement property. This dictates many items that will affect you.

How to increase basis in replacement property.

The question many investors ask is how do you change the dynamics on the exchange and potentially increase tax favored write offs? One strategy would be to purchase up, meaning a more expensive replacement property. Rather than buying a $400,000 property in Daytona Beach hypothetically they purchase a $500,000 property. Their basis in the property would be increased by $100,000. This is a combination of the rollover $77,000 plus the $100,000 for a total of $177,000. There would be 7½ years remaining on the $77,000 and the $100,000 would start on a 27 ½ year depreciation schedule. The updated depreciation schedule shows the continued depreciation of the New Jersey homes (as if they still owned it) and the acquisition of the Daytona Beach property portion as of the date they closed on the Daytona Beach property.

Bring more cash or acquire more debt!

In order to increase the purchase price, the investor would need to bring additional cash or arrange for a mortgage or loan for the $100,000. This may involve applying for a loan. In most cases the investor would need to sign for and be liable for the loan. To avoid personal liability for a loan, some investors utilize Delaware Statutory Trust (DST) as a replacement property especially when leverage is present. DST have non-recourse debt. This eliminates the need for Jack & Diane to apply for or be liable for any of the assigned debt on the new acquisition. We have guided investors who have fully depreciated their investment properties who acquired a DST with 50% Loan to Value. This would increase the basis by an additional the amount of the debt assignment ($400,000 for example). Acquiring additional debt is not for all investors. If the investor utilized a future 1031 exchange the acquired debt (or balance paid off) needs to be replaced. The other consideration would be the overall goals of the investor when acquiring a property and in this example the Daytona Beach property may have other uses in the future.

Step Up in Basis

The final basis would be referenced as the step-up basis. This strategy benefits the heirs of the investor. When the investor passes away there is an adjustment from the original basis to the current market value. If the original property was purchased for $175,000 fully depreciated (over 27.5 years) and now worth $750,000 that is the new basis. The basis has been stepped up to current value. If the property is sold there would be no capital gains taxes due and there would be no recapture of depreciation taken. This strategy may be utilized to build generational wealth.

As previously stated, we are not CPA. We have guided many investors with a list of questions for their CPAs and assisted in countless 1031 exchange consultations. We have also assisted in the acquisition of DST utilizing the 1031 process. Call with any questions you may have. DSTs are not for all investors. The acquisition of a DST is for accredited investors only. Contact your investment adviser for additional details on how a DST may be a solution to your 1031 Exchange and suited for your investment future. For more information on how to properly set up an IRC 1031Tax Deferred Exchange or if you are an accredited investor and would like additional information on a DST contact Al DiNicola at 239-691-8098 or email adinicola@namcoa.com.

This is not an offer to purchase or solicitation to purchase any security, as such be made only through an offering memorandum or prospectus. Investing in securities, real estate, or any investment, whether public or private, involves risk, including but not limited to the potential of losing some or all of your investment dollars when you invest in securities. You should review any planned financial transactions that may have tax or legal implications with your personal tax or legal advisor. NAMCOA, LLC is a Registered Investment Advisor, regulated by SEC (Securities and Exchange Commission). Our corporate office is located at 999 Vanderbilt Beach Road, Suite 200, Naples Florida 34108. Securities Offered through MSC-BD, LLC, Member of FINRA/SIPC. 8215 SW Tualatin -Sherwood Rd, Suite 200 Tualatin, OR 97062. MSC-BD, LLC and NAMCOA are independently owned and are not affiliated.

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