By Al DiNicola

DST.Investments, LLC- Registered Investment Advisor

June 15, 2020

Financial advisers, CPAs and Attorneys interface with investors and provide valuable insight into planning for generational wealth transfer, occasionally referenced as a family legacy. This trust bond may have taken years to develop or may develop quickly with sound financial advice.  Professionals deal with situations which may have recurring themes. However, the professional must understand each and every situation prior to suggesting the alternatives. 

Recently, we had the pleasure of working with a family and we were able to suggest alternatives for their specific needs.  The patriarch of the family had recently passed away in his late 80’s. The matriarch was in an assisted living facility, in her mid-80’s and in failing health.  Over the years, the patriarch and matriarch had assembled a real estate holding portfolio in a coastal Florida town.  The commercial and residential rental properties served the family well for over twenty years. Some of the properties were free and clear of any debt but there were a few with mortgages on the properties. One of the three siblings (now all in their 60’s) was charged with the responsibility of managing the real estate. After 10 years of active management of the assets, the managing sibling was searching for an alternative.   The first alternative was to simply sell all the real estate (on an accelerated plan) and pay the capital gains tax as well as recapturing all the depreciation and paying the tax at a rate of 25%. The second was to attempt to do a 1031 Exchange and defer the taxes.  The 1031 posed a few obstacles with the replacement of debt. The main obstacle was the matriarch signing on the loan for the debt replacement.

The family was looking for a source of monthly income, without the stress of management or even dealing with a management company in the case of an individual commercial building with a Triple New Lease (NNN).  The family also understood that outright selling the real estate while the mother was still living may forfeit the step up in basis to current value.  For those not familiar with this provision this is the readjustment of the value of an appreciated asset for tax purposes upon inheritance. This would mean the property owner would pass ownership upon their death. This minimizes the capital gain taxes that may be due.  In the case of this family, the taxes that would have been due were just under $1.6MM if the property was sold outright and not pass to the heirs.

There still is a need for the mother to receive some sort of monthly income. The other fact would be the three siblings will eventually inherit the asset (property). The solution was to execute a 1031 tax deferred exchange and purchase a variety of DST assets which all included removing management concern as well as the debt replacement. We analyzed the proposed closing statement from the sale of the investment properties. There were four total investment properties that were to be exchanged.  We analyzed the payoff of the loans on the properties since one of the requirements of a 1031 is the debt needs to be replaced.  The DST also provide non-recourse debt. This means there is no requirement to sign for the loan that is in place for the DST. We also evaluated the amount of equity that would be available for acquisition of the DSTs. We counseled the siblings on the selection of a Qualified Intermediary (QI) to hold the funds. All transactions must be through a QI.

The result was a diversified portfolio of multiple DSTs in a variety of assets and geographic locations. While the DST are operating the mother receives monthly income directly into her account. Since there are multiple DST and more than likely different periods of eventual sales of the DST the family can evaluate what the next steps would be at that time. If the mother is still living the family can do successive 1031 exchanges into other DST or even out of the DST back into regular real estate. These additional alternatives provide additional flexibility. The family can now enjoy the best of both worlds the disclosures of a security and the tax advantages of real estate.

When the mother passes away, the assets transfer to the siblings with a step up in basis for tax purposes.  Each sibling can be assigned a different DST for their own accounts. The siblings would receive the monthly income from the DST during the life of the DST. Once the DST reaches full term and is sold the siblings would be in line to receive the proceeds from the DST. The siblings would have a variety of options on the disposition of the asset once the DST would be sold.  The individual sibling would receive the proceeds from the DST. The individual siblings would be free to take the proceeds with the added factor of a step up in basis.

As always consult your CPA or financial adviser.  We specialize in DST structure and function.

For more information on how to properly set up an IRC 1031 Tax Deferred Exchange or if you are an accredited investor and would like additional information on a DST contact Al DiNicola at 239-691-8098.