A 1031 exchange of property is a powerful tax deferral strategy that allows you to defer your capital gains taxes. The 1031 Exchanges are desirable for accelerating capital growth when profits come from real estate. However, you can do property exchange through Delaware Statutory Trusts (DST) to reap maximum benefits. Here are requirements you need to adhere to and strategies to help you benefit from the taxes deferral.
Table of contents
- Identifying Replacement Property Timelines
DST helps you sell your property with a deferral to pay your taxes on capital gains till later. However, you must adhere to some rules and guidelines to fully benefit and take advantage of the 1031 exchange deferral benefits.
Once you sell your property under the dst 1031 exchange, you have to ensure you identify your preferred replacement property within 45 days after the sale of your relinquished property. The 45-day window is known as the identification period.
The identification must be in writing, and the investor must sign the document. The parties must deliver the copy to the seller of the replacement property. However, the parties should not take the identification document to a disqualified person who has an agency relationship with the investor. The law deems that a disqualified person will likely break the rules due to their close relationship with the investor. Disqualified persons include the investor’s team member, accountant, lawyer, or estate agent.
2. Acquiring of Replacement Property Timelines
Under Delaware Statutory Trusts (DSTs), which operate within the 1031 Exchange requirements, the investor has 180 days, or less in some circumstances, to acquire one or more of the properties they have identified. The 180 days is known as the property exchange period.
The rule on the identification period and exchange period resulted from the Starker case. The taxpayer took five years from the time of relinquishing their property to purchasing replacement property.
3. Property Must Be For Productive Use
It is a tax requirement that the property you exchange under 1031 exchange must be for productive use in a trade or business or investment during the entire deferral period. If it is not, gain on the exchange will give rise to UBTI and other tax consequences. The exchange property could be multifamily apartments, medical offices, office buildings, senior living facilities, student housing, and industrial properties.
4. Like-Kind Exchange Rule
When you sell your property under Delaware Statutory Trusts, the replacement property must be a like-kind to the relinquished property for you to take full advantage of the tax deferral. For example, if the replacement property has an incidental property that was not part of the relinquished property, then the investor will pay boot taxes for the Incidental Property.
Like-kind exchange rules are one of the most interesting IRS tax rules for real estate investors. In a nutshell, the 1031 rule allows you to defer capital gains taxes when you reinvest profits from one investment property into another similar investment property. The 1031 exchange process is also known as a deferred exchange.
5. Property and Sale Proceeds Transfer Is Through A Third Party
Under 1031 exchanger, IRS tax laws dictate that you cannot transact and complete an exchange directly with a buyer without a registered third party to set up the sale for you. The law then creates a role for the Delaware Statutory Trusts(DSTs) who transact sale proceeds and property on behalf of both parties.
DST is an ownership model that allows co-ownership of property among registered investors with the main aim of benefiting from tax deferrals under the 1031 exchange. DST offers simplicity and personal guarantee to investors.
Conclusion
The nature of how property exchange takes place has shifted towards using Delaware Statutory Trusts or DSTs to facilitate trades that qualify under Section 1031 of the Internal Revenue Service code. The beauty of 1031 Exchange DSTs is that they can provide you with a seamless transition from one property to another. The IRS guidelines under IRC Section 1031 allow a taxpayer to defer gain from the exchange of an asset used in a trade or business for a replacement. Deferral of capital gains may also apply to a residence if you sell and buy a replacement residence within the time frame permitted by law.
