How Delaware Statutory Trusts Offer Three Key Benefits 

Real estate investors often encounter unique challenges as they approach retirement and prioritize estate planning. Over the years, their real estate assets tend to appreciate in value, while annual depreciation gradually reduces the property's cost basis. Consequently, selling a property before the investor's demise can lead to significant capital gains taxes. However, it's not uncommon for the investor's heirs to lack interest in actively managing these real estate holdings once they inherit them.

In such cases, an effective solution that I have witnessed as a seasoned financial investor with 30 years of experience is the utilization of a 1031 Exchange into a Delaware Statutory Trust (DST). By opting for a DST, investors can sell their properties without incurring immediate tax consequences, while also benefiting from potential consistent income derived from real estate investments. Additionally, this approach allows for the preservation of the eventual step-up in basis upon the investor's passing, which can further enhance the financial benefits for their heirs.

What is A Delaware Statutory Trust?

Customer signing a contract for buying a house illustrating the process of investing in real estate using a 1031 exchange for tax deferral

A Delaware Statutory Trust (DST) is a legally recognized trust structure established for business purposes. It is often referred to as an Unincorporated Business Trust (UBO). DSTs are predominantly formed in Delaware due to the state's favorable statutory trust law. In 2004, the Internal Revenue Service (IRS) granted approval for qualified DSTs as a viable investment option for individuals seeking to reinvest their funds from a 1031 Exchange.

Rather than acquiring replacement rental properties, investors have the opportunity to reinvest their proceeds into a Delaware Statutory Trust while deferring capital gains taxes. Whether the proceeds are allocated to a single trust or distributed among multiple trusts, each investment is treated as an exchange-qualified co-ownership. Essentially, from the perspective of the IRS, investing in a DST is equivalent to purchasing another 1031 Exchange-qualified real estate property.

One of the primary appeals for retiring investors or those looking to pass on assets to their beneficiaries is the combination of tax benefits and potential monthly income provided by a DST. By participating in a DST, investors can enjoy the advantages of a 1031 Exchange while alleviating themselves from the responsibilities associated with owning and managing additional properties.

Delaware Statutory Trusts (DSTs) offer several estate planning benefits that sophisticated investors often recognize. By implementing a DST strategy, beneficiaries can enjoy advantages such as the avoidance of capital gains taxes on inherited real estate, the minimization of disagreements among heirs, and the facilitation of charitable giving. Let's explore these benefits in more detail:

1. Elimination of Capital Gains Tax:

When an investor passes away, estate beneficiaries receive a stepped-up basis for tax purposes. This means that the beneficiaries are not required to pay capital gains taxes on the accumulated appreciation of the inherited property from the time it was originally acquired until the investor's death. This also includes any deferred capital gains on real estate that was previously involved in a 1031 Exchange and subsequently transferred into the DST.

Consequently, when a beneficiary sells an asset, the tax basis is stepped up to the value as of the date of the investor's death. It is important to note that while capital gains tax on inherited property can be avoided, assets held within a Delaware Statutory Trust are still considered part of the investor's estate. Therefore, normal estate tax rules and exclusions apply. To understand the implications for your specific estate, it is recommended to consult with an estate planning professional.

2. Flexible Distribution of Trust Assets to Beneficiaries:

A Delaware Statutory Trust (DST) can help minimize disagreements among partners and heirs regarding the distribution of trust assets. Upon the passing of an investor, there may be varying opinions on how to handle the assets, particularly when it comes to larger assets like real estate investments that are challenging to divide equitably.

In such cases, some investors take a proactive approach to avoid potential conflicts. By incorporating a DST into their estate plan, they can sell their real estate holdings and allocate the proceeds into different trusts. Each investment can be clearly identified and distributed to individual beneficiaries, granting them more control over the assets without involving other family members. This flexible distribution mechanism provides a practical solution to potential disputes.

3. Simplified Distributions to Charities:

Delaware Statutory Trusts also streamline the process of leaving real estate investments to charitable organizations. If a charity is designated as a beneficiary of real estate assets, it may lack the capacity or desire to actively manage the properties. In such situations, the charity might opt for an immediate liquidation of the property, even if its value is temporarily impacted by economic conditions. However, with a DST, the charity can receive the investor's interest in the trust without assuming day-to-day management responsibilities for rental properties.

The charity can benefit from potential monthly income generated by the trust until the sponsors of the DST determine the opportune time to sell the underlying assets. As each property within the trust is sold, the charity will receive its designated portion of the proceeds. This streamlined approach ensures that the charity maximizes the potential benefits of the donation without having to handle property management intricacies.

DST PROPERTY MANAGEMENT

In a Delaware Statutory Trust (DST), the trust sponsor assumes the responsibility of making all decisions on behalf of the trust's investors. This structure allows investors to own real estate assets without the typical challenges and burdens associated with being a landlord and property owner. DSTs serve as legal entities that enable real estate investors to sell their properties and utilize a 1031 Exchange to defer capital gains taxes on the appreciated value of their real estate.

When participating in a DST, an investor's funds are typically pooled with those of other investors to acquire larger or multiple assets through the trust. These investments are treated as a direct interest in real estate for the purposes of IRS Section 1031.

Upon making an investment in a DST, owners have the potential to receive income from the trust's underlying real estate assets, typically on a monthly basis. It is important to note that the trust is required to retain a portion of its income in reserves, as it is not permitted to take on debt or request additional capital once it has completed its initial offering or closed.

By utilizing a DST, investors can benefit from professional property management and avoid the day-to-day operational responsibilities typically associated with owning and managing individual properties. The trust sponsor assumes the role of making strategic decisions and overseeing the management of the trust's real estate assets, providing investors with a hassle-free ownership experience.

Fractional Ownership of Institutional-Grade Real Estate

One of the advantages of investing in a Delaware Statutory Trust (DST) is the opportunity for fractional ownership of institutional-grade real estate. Many real estate investors tend to focus on specific property types or regions based on their expertise, preferences, or proximity to attractive investment opportunities. However, with a DST, investors have the advantage of pooling their exchange proceeds with other investors, enabling the trust to own larger properties that individual investors may not be able to acquire on their own.

By participating in a DST, investors can diversify their investments across multiple trusts, allowing them to select and tailor their investment strategies based on their objectives. This flexibility enables investors to choose from various property types, geographic regions, and investment strategies that best align with their goals.

DSTs offer a wide range of industries and property types within their portfolios, including multi-family or student housing, healthcare facilities, office buildings, storage units, and retail properties. When considering DST options, it is important to inquire about the specific types of properties included in the offering to ensure they align with your investment preferences and objectives.

Delaware Statutory Trust Taxes

Delaware Statutory Trusts (DSTs) formed in Delaware benefit from the state's favorable tax environment. Delaware does not impose a Franchise Tax or income tax on statutory trusts established within its jurisdiction. This absence of state-level taxes reduces expenses associated with the trust, allowing more income potential to be retained by investors.

However, it's important to note that tax obligations are passed through to each individual investor in the DST. The tax liabilities are distributed proportionally based on the investor's investment in the trust. As a result, investors may receive 1099 and 1098 forms from the sponsor of the DST each year, reflecting the income and interest generated by the trust's portfolio performance. Additionally, an income statement is provided to facilitate the calculation of depreciation for tax purposes.

One significant advantage of investing in a DST is the simplified tax planning it offers for estate purposes. The monthly accounting of revenues and expenses is managed by the trust sponsor, which streamlines the tax reporting and planning process for investors. This alleviates the need for individual investors to handle the intricacies of tracking and reporting revenues and expenses related to the DST, thus providing convenience and ease in managing the tax aspects of the investment.

Here are the disadvantages of Delaware Statutory Trusts 

Young man signing a contract for buying a house with a real estate broker illustrating the process of investing in real estate using a 1031 exchange for tax deferral despite potential disadvantages

While Delaware Statutory Trusts (DSTs) offer several advantages, it's important to consider the potential disadvantages before deciding to utilize this strategy in your estate planning. Consulting with a licensed 1031 Exchange professional is recommended for a comprehensive evaluation of the pros and cons. Here are a couple of disadvantages to consider:

No Input on Decisions:

DSTs are passive investments managed by the trust's sponsor. The IRS approval conditions dictate that investors cannot have operational control or decision-making authority over the underlying properties. While a trust sponsor may be open to receiving feedback, they are not obligated to follow investors' recommendations.

This lack of control can be challenging for investors who are accustomed to being the final decision-maker on their investments. However, beneficiaries who have no interest in taking over the family real estate business may appreciate the hands-off approach that DSTs provide.

Illiquid Investments:

Investing in a DST involves acquiring a fractional interest in the trust, which can make it more challenging to liquidate part or all of your investment. Unlike listing an individual real estate property for sale, liquidating a DST investment is not as straightforward.

Investors should anticipate that their investment will remain tied to the trust until the properties held by the trust are sold. Unlike the stock market, there is no public market where investors can easily sell their interest in a DST. Therefore, DST investments should be approached with the understanding that they are generally illiquid and require a longer-term investment horizon.

It's crucial to evaluate these potential drawbacks alongside the advantages of DSTs and assess how they align with your specific investment goals and preferences.

Moderate To Long-term Hold Periods

Another disadvantage of Delaware Statutory Trusts (DSTs) to consider are the moderate to long-term hold periods associated with these investments. The trust sponsors typically adopt a long-term perspective for their investments, which means investors should anticipate a hold period ranging from 5 to 10 years before being able to access their investment. While many investors in rental real estate properties already expect to hold their assets for an extended duration, the inability to liquidate the investment early, if needed, can be a source of concern for some individuals.

Cannot Raise New Capital

Additionally, it's important to note that once a DST has closed, it cannot raise new capital from existing or new investors. The ongoing maintenance and capital improvements required by the trust must be funded by the reserves set aside by the trust.

This allocation of reserves reduces the amount of cash available to distribute to investors on a monthly basis. In cases where there are insufficient reserves available, the sponsor may need to sell one or more properties to ensure that there is enough cash flow to meet the trust's obligations.

Understanding these moderate to long-term hold periods and the limitations on raising new capital is crucial when considering DST investments. It is recommended to carefully evaluate your liquidity needs and investment time horizon to ensure they align with the characteristics of a DST investment.

Cannot Be Refinanced

Another important disadvantage to consider is that Delaware Statutory Trusts (DSTs) cannot be refinanced once the trust has closed, according to IRS rules. While not all DSTs have loans against their underlying properties, if there are loans in place, the inability to refinance can have implications for both the sponsor and investors.

In cases where the properties within the DST have loans, this restriction means that the sponsor cannot take advantage of potential drops in interest rates. If there is a decrease in interest rates, the sponsor is unable to refinance the loans to secure a lower rate, which could have been beneficial in reducing costs and increasing cash flow potential.

Conversely, if a property within the DST has a variable rate loan and interest rates increase, the sponsor is also unable to refinance the loan to lock in a lower rate before rates climb even higher. This can result in higher mortgage payments, potentially leading to reduced cash flow for investors. In extreme cases, the property may become unprofitable, necessitating a sale before it was initially planned.

It's important to understand the implications of the inability to refinance loans within a DST, particularly in a changing interest rate environment. Investors should carefully assess the potential impact on cash flow and profitability when considering DST investments.

Learn More About Delaware Statutory Trusts (DSTs)

If you are interested in learning more about Delaware Statutory Trusts (DSTs) and considering them for your 1031 Exchange, contact us to schedule a complimentary consultation with one of our licensed 1031 Exchange professionals. We offer free consultations that can be conducted over the phone, via web, or in person to accommodate your preferences.

During the consultation, our experienced professionals can provide you with valuable insights and information specific to your situation. They can address any questions or concerns you may have about DSTs, guide you through the process, and help you make informed decisions regarding your 1031 Exchange.

To schedule your free consultation, please visit us at perchwealth.com. We look forward to assisting you with your DST and 1031 Exchange needs.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing. Any information provided is for informational purposes only.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication. 

1031 Risk Disclosure: 

Unlock the Potential: 1031 Exchange Into a REIT and Seek Potential Rewards

While some real estate professionals argue that a 1031 exchange into a Real Estate Investment Trust (REIT) is not feasible due to the contrasting nature of real property assets and REIT shares, the truth is that with careful navigation, it can be accomplished. However, it requires following intricate procedures to ensure a seamless exchange.

Curious to learn more? Dive into the world of real property, 1031 exchanges, and REITs, and discover the path to exchanging your investment property for REIT ownership.

Distinguishing Between Real Property and Securities: Exploring 1031 Exchanges and REITs.

When it comes to investment property, the IRS classifies it as "real property," a tangible asset that can be exchanged for similar assets under Section 1031 of the Internal Revenue Code. This allows investors to defer capital gains taxes by reinvesting the proceeds into like-kind properties within a specific timeframe.

On the other hand, Real Estate Investment Trusts (REITs) operate differently. While they also deal with real estate properties, the investment structure revolves around investors purchasing shares in the REIT rather than owning the properties directly. REITs seek to generate cash through dividends, not rental income, which categorizes them as securities rather than real property.

It's important to note that a direct exchange from real property to a security is not permissible in a tax-deferred 1031 exchange since they are not considered like-kind assets.

Navigating the Path: Transitioning from Real Property to REIT Investment

If you aspire to transition from owning real property to becoming a REIT investor, you can achieve this by exchanging your real property assets for shares in a Delaware Statutory Trust (DST). Subsequently, you have the option to convert your DST shares into Operating Partnership (OP) units through an Umbrella Partnership Real Estate Investment Trust (UPREIT).

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To reach your desired destination of REIT investment, consider the path of fractional ownership in a DST and its conversion into UPREIT OP units. Many REITs offer UPREITs as a means for DST investors to convert their interests into OP units within the UPREIT structure. By making this conversion into a partnership, you can still defer capital gains taxes, unless you choose to convert your UPREIT OP units into REIT shares.

This type of exchange comes with potential advantages and risks:

  1. Liquidity: Real property assets lack liquidity, but by exchanging your UPREIT OP units for REIT shares, you can access liquidity. However, keep in mind that this may trigger taxable events.
  2. Diversification: Instead of relying on a single property for cash flow, investing in UPREIT allows you to hold interest in a portfolio of assets with the potential for increased balance against economic volatility.
  3. Efficient estate planning: Passing down UPREIT OP units to heirs can provide a stepped-up basis, eliminating accumulated capital gains taxes (unless the units are converted into REIT shares).

It's crucial to note that once you complete the UPREIT process, you cannot execute a 1031 exchange to revert back to real property. Your investment must remain in the form of UPREIT OP units to continue deferring capital gains taxes.

Breaking It Down: Understanding the UPREIT Process

To better understand the UPREIT process, let's delve into how it works from both the perspective of the sponsor and the investor:

  1. Sponsor's Role:

The sponsor typically selects a high-quality asset, either from an existing REIT or through a new acquisition, and places it into a newly formed Delaware Statutory Trust (DST).

During the syndication period, the DST offers a predetermined amount of equity to investors, including those seeking 1031 exchanges. Investors acquire beneficial interests in the trust and have the potential to receive distributions similar to a standard DST investment.

2. Investor's Journey:

Investors become part of the DST by acquiring beneficial interests in the trust, enabling them to participate in the investment and receive the potential for regular distributions.

After a hold period of approximately two to three years, which satisfies the IRS safe-harbor guidelines for investment properties, the sponsor initiates a Section 721 UPREIT transaction for the property held under the trust.

As part of this transaction, investors have the opportunity to exchange their DST beneficial interests for operating partnership (OP) units in an entity owned by the REIT.

Following a predetermined lockout period, investors may have the option to redeem their OP units. They can choose to convert them into common stock in the REIT or receive cash, subject to the terms and conditions specified by the REIT.

Understanding the UPREIT process involves recognizing the roles of both the sponsor and the investors. The sponsor identifies and places a suitable asset into the DST, while investors participate by acquiring beneficial interests and later have the opportunity to exchange them for OP units. The ability to redeem OP units for common stock or cash becomes available after a lockout period, subject to the specific terms established by the REIT.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing. Any information provided is for informational purposes only.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

1031 Risk Disclosure:

·     There’s no guarantee any strategy will be successful or achieve investment objectives;

·     All real estate investments have the potential to lose value during the life of the investments;

·     The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities;

·     All financed real estate investments have potential for foreclosure;

·     These 1031 exchanges are offered through private placement offerings and are illiquid securities. There is no secondary market for these investments.

·     If a property unexpectedly loses tenants or sustains substantial damage, there is potential for suspension of cash flow distributions;

·     Costs associated with the transaction may impact investors’ returns and may outweigh the tax benefits

Can 1031 Exchanges be Subjected to Audits?

When it comes to tax returns, it's essential to keep in mind that the IRS has the authority to audit any tax return, including those involving 1031 exchanges. However, due to limited resources, the IRS tends to concentrate its efforts on returns that show potential for substantial gains, from the IRS's perspective.

In practice, less than 0.4% of tax returns are audited, indicating that the vast majority of taxpayers can breathe a sigh of relief. Of those that are audited, approximately 85% are subject to simple requests for extra documentation generated by computers. These requests can typically be addressed by mailing the requested information to the IRS and require minimal effort on the taxpayer's part.

It's important to note that while the odds of being audited are relatively low, they are not zero. Furthermore, the 2022 Inflation Reduction Act provided funding for increased enforcement efforts by the IRS, which may lead to more audits in the future.

Therefore, it's always a good idea to ensure that your tax return is accurate and complete and to retain any documentation related to your 1031 exchange for at least three years after the exchange. This way, if the IRS does decide to audit your return, you will have the necessary paperwork to support your claims.

real-estate-investor-examining-financial-records-to-prepare-for-an-IRS-audit-tax-returns-1031-exchanges-MA

Wealthy taxpayers have a low audit probability (1%), while low-income taxpayers claiming the earned income tax credit are at a higher risk (13%). Taxpayers with high business or farm income (over $200,000) have a slightly lower audit chance than low-income taxpayers. However, the following actions can trigger an audit:

●     Failing to report all income

●     Making math errors

●     Claiming higher than average deductions or losses

●     Claiming higher than expected charitable deductions compared to income

●     Operating a business

●     Claiming business losses for hobby expenses

●     Claiming large rental losses

●     Incorrectly reporting the Health Premium Tax Credit

●     Taking an early withdrawal from a 401(k) or IRA

●     Conducting digital asset and virtual currency transactions

●     Underreporting gambling wins or overreporting gambling losses

●     Claiming a research and development credit.

Red Flag Issues

The IRS may identify red flag issues with some 1031 exchanges, which allow taxpayers to reinvest the proceeds from selling real estate in "like-kind" property and defer the recognition and payment of capital gains from the sale. For instance, if a taxpayer sells an office building for $800,000, which they purchased for $500,000 three years ago, they could potentially have a capital gain of $300,000. By using a 1031 exchange, the taxpayer can defer taxes due on that gain and delay a depreciation recapture payment.

Successfully completing a 1031 exchange can be challenging, and taxpayers must carefully follow the IRS rules to avoid disqualification of the exchange attempt. Some of the provisions that can pose difficulties include:

●     Tight timelines: The investor must complete the exchange within 180 calendar days of selling the original property, with a 45-day window to identify potential replacement properties. To comply, the taxpayer must notify the Qualified Intermediary of the possible replacements, following specific rules.

●     Three properties rule: The taxpayer can identify up to three potential acquisitions with no limit on the individual or aggregate value.

●     200 percent rule: The taxpayer can identify any number of potential replacements, but the combined value of all properties cannot exceed 200 percent of the value of the relinquished asset.

●     95 percent rule: The taxpayer can identify any number of properties with any individual or combined value but must acquire 95 percent of the total identified property value before the deadline.

investment-portfolio-preparing-for-audit-by-IRS-Massachusetts

The 1031 exchange process involves several challenging provisions, and taxpayers must carefully follow IRS rules to succeed. Here are some of the key considerations:

Engaging a Qualified Intermediary: Taxpayers must use a Qualified Intermediary to receive the potential replacement properties and safeguard the proceeds until the replacement property's acquisition. The Qualified Intermediary must maintain a separate account for the funds and can't be related to the taxpayer, a close business associate, or an agent.

Like-kind exchange: The IRS allows almost any exchange of investment and business property as long as the properties are "like-kind." However, taxpayers may not exchange a personal residence and must hold the property for two years before trading it. Flipped properties are also ineligible for the exchange.

Matching value and debt level: The replacement property must have the same or greater market value as the relinquished asset, and if the original property is encumbered, the replacements must carry an equal debt level.

To maximize potential tax relief, taxpayers should consider including the 1031 exchange in their tax planning. However, like other activities that could trigger an audit, it's essential to keep meticulous records to support any deductions, credits, or deferrals claimed on tax returns.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing. Any information provided is for informational purposes only.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

1031 Risk Disclosure:

Is Capital Gains Tax Applicable to Stock Options?

When it comes to taxes, stock options can be a desirable benefit for employees, but it can also raise questions about capital gains. In this article, we'll dive into the details of capital gains and how they apply to stock options, so employees can better understand the tax implications of this popular employer perk.

Capital Gains

When it comes to capital gains and stock options, it's important to understand how they are taxed. A capital gain is the profit made from selling a capital asset such as stocks, bonds, or real estate for more than the original purchase price. How long the asset was held before selling it determines whether the gain is considered short-term or long-term.

Short-term capital gains are gains from selling assets held for one year or less and are taxed as ordinary income, which can be as high as 37% for the tax year 2022, depending on your tax bracket. On the other hand, long-term capital gains are gains from selling assets held for more than one year and are taxed at a lower rate than short-term gains.

The tax rate for long-term capital gains depends on the taxable income and ranges from 0% to 20%. The majority of individual taxpayers pay a tax rate on net capital gains of no more than 15%, according to the IRS.

Stock Options

Stock options are a popular form of compensation used by companies to attract and retain employees. Essentially, stock options are contracts that give the employee the right to buy a certain number of shares of the company's stock at a pre-determined price, known as the grant price. This grant price is typically lower than the current market price of the stock, which allows the employee to potentially make a profit if the stock price rises.

Stock options come in different forms, including non-qualified stock options (NSOs) and incentive stock options (ISOs). NSOs are more common and are typically offered to all employees, while ISOs are reserved for executives and other key employees. ISOs have more favorable tax treatment, but they also come with more restrictions and rules.

capital-gains-tax-deferral-stock-options-vs-real-estate-investing-investment-strategies-IRS-regulations-retirement-planning

When a company offers stock options as compensation to its employees, it grants them a contract that allows the employee to purchase a set number of shares of the company's stock at a predetermined price, which is usually lower than the current market value. While holding the stock options, the employee does not have an ownership interest in the company, but exercising them to buy the stock provides them with the ownership interest.

There are two types of stock options: statutory and non-statutory. Statutory stock options are granted under either an employee stock purchase plan or an incentive stock option (ISO) plan, which both have specific rules and regulations that must be followed. Non-statutory stock options, also known as non-qualified stock options (NSOs), are granted without any type of plan and are typically more flexible in terms of their terms and conditions.

Capital Gains and Stock Options

When it comes to capital gains and stock options, the tax implications start when the options are exercised. At that point, the tax liability is based on the difference between the fair market value of the shares and the exercise price. This difference is known as the "spread". The spread is taxed as ordinary income, subject to income tax withholding and payroll taxes.

When an employee sells the shares acquired through exercising their stock options, any gain or loss is treated as a capital gain or loss. If the shares have been held for more than one year, any gain is subject to long-term capital gains tax rates, which are generally lower than ordinary income tax rates. However, if the shares have been held for one year or less, any gain is subject to short-term capital gains tax rates, which are the same as ordinary income tax rates.

The tax treatment of stock options also differs depending on whether they are statutory or non-statutory options. Statutory stock options, such as those granted under an employee stock purchase plan or incentive stock option (ISO) plan, have special tax treatment. When ISOs are exercised and the shares are sold, the gain or loss is generally taxed as a long-term capital gain or loss. However, there are certain holding period and other requirements that must be met for the special tax treatment to apply.

Non-statutory stock options, also known as non-qualified stock options (NSOs), do not receive the same special tax treatment as ISOs. Instead, the spread between the fair market value of the shares and the exercise price is taxed as ordinary income when the options are exercised. Any gain or loss on the sale of the shares is then taxed as a capital gain or loss.

It is crucial to hold stocks obtained through an employer's stock options program for at least a year, regardless of whether they are ISOs or NSOs, to take advantage of the lower tax rate for long-term capital gains.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing. Any information provided is for informational purposes only.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

 

Ensuring Your 1031 Exchange is Successfully Transacted

Selling investment or business real estate can be costly, but a 1031 exchange can help preserve gains and generate wealth. Under Section 1031 of the federal tax code, no gain or loss is recognized on the sale of a real estate property held for business or investment purposes if a replacement property of equal or greater value is purchased. However, the 1031 exchange process can be complex. To help guide your clients through a successful exchange, consider these steps:

Step 1

Be aware of the deadlines set by the IRS. Investors have 45 days to identify a replacement property and 180 days to close on it after selling the relinquished property. It may seem like a short time frame, but it is manageable with the help of a professional 1031 exchange investment firm such as Perch Wealth.

Step 2

The IRS requires that an exchanger reinvest in a “like-kind” property, but this does not necessarily mean the same type of property. There are various options available. For example, if you are selling a duplex, you don't have to replace it with another duplex.

The 1031 exchange allows investors to replace relinquished real estate with different types of assets such as a medical building, single-family home, multifamily apartment building, raw land, self-storage facility or any other investment real estate as long as it is held for investment or business purposes.

It is best to know what you are looking for in a replacement property before going into escrow on the property you are selling. Working with a 1031 exchange investment firm like Perch Wealth can greatly reduce the stress and confusion surrounding 1031 exchanges.

planning-a-successful-transaction-with-1031-exchanges-Massachusetts-MA-investors-strategy-tax-saving-initiatives

Step 3

It is not uncommon for 1031 exchange investors to feel overwhelmed and stressed when they reach the 30-day mark of their 45-day window without a replacement property identified for their exchange. However, with some planning and preparation, you can avoid this situation.

A good strategy is to identify five to ten potential replacement properties as the closing date of the property you are selling approaches. Keep in mind that some of these properties may be acquired by other buyers or may not be suitable after further evaluation, which is why it is important to have a short list of potential replacement properties before relinquishing the original asset. This can help prevent your 1031 exchange from falling apart.

Step 4

It is not uncommon for investors to call in a panic because they have found a replacement property, but they are unable to secure financing to purchase it. To avoid this stressful and potentially costly situation, it is important to ensure that financing is in place before closing on the property being sold.

One solution is to consider fractional ownership structures for 1031 exchanges, such as a Delaware Statutory Trust (DST) investment for accredited investors. DSTs have a non-recourse financing component built-in, so the investor does not need to sign for a loan. This can make a DST an ideal opportunity for an investor looking for a passive, turn-key solution with pre-established financing for their 1031 exchange.

Step 5

According to the IRS code, investors have options for identifying replacement properties for their 1031 exchange. The most common methods are identifying three properties at any value or identifying real estate valued at up to 200% of the property being sold.

This allows for back-up options. It is important to take advantage of this opportunity and not leave any empty spaces on the ID form submitted to the qualified intermediary. Often, the primary option may not work out, and having back-up options can strengthen the investor's negotiating power by providing additional choices.

 For accredited investors, a Delaware Statutory Trust (DST) can be an excellent back-up strategy. DST properties are already purchased, stabilized, and may provide monthly distributions to investors. There is no need for negotiation and due diligence is already complete.

Additionally, closing on a DST can often be done in three to five business days. It is a good idea to consider using a DST as a back-up ID if there is room in the exchange and it is appropriate for the investor's situation.

Step 6

When entering into a purchase and sale agreement, it is important to include a 1031 contingency clause. Many buyers are willing to allow a 1031 contingency that allows the seller to extend escrow on the property being sold if the seller is unable to find a replacement property. For example, try to negotiate a clause that extends escrow by an additional 30 days in case you are unable to identify a suitable replacement property. This can provide extra time if needed when locating the right 1031 exchange investment.

In summary, a 1031 exchange can be a valuable tool for building and preserving wealth, but it can also be a challenging process if not properly prepared. To ensure a successful exchange, start early, educate yourself, narrow down options, secure financing, have a back-up plan, and negotiate for more time if needed.

For accredited investors, consider using a Delaware Statutory Trust (DST) as part of your 1031 exchange strategy. Keep in mind that there are no guarantees in real estate, so it is always best to plan ahead when considering a 1031 exchange.

How 1031 Exchanges Differ from a Traditional Real Estate Sale

A 1031 exchange, also known as a Starker or like-kind exchange, is a powerful tax-saving strategy that allows real estate investors to defer taxes on the sale of a property by using the proceeds to purchase a similar "like-kind" property. This allows investors to reinvest their capital in new properties, without having to pay taxes on the sale of the previous property.

1031 exchanges can be a useful tool for real estate investors looking to defer taxes, diversify their investment portfolio, and increase their overall returns. However, it's important to understand the rules and regulations that must be followed in order to properly execute a 1031 exchange.

The IRS has strict guidelines for 1031 exchanges, including the requirement that the property being sold and the property being purchased must be used for investment or business purposes. This means that primary residences do not qualify for a 1031 exchange. Additionally, there is a 45-day identification period during which the investor must identify up to three potential replacement properties, and the investor must complete the exchange and acquire one of those properties within 180 days of selling the original property.

It's also important to note that there are restrictions on the type of transactions that qualify for a 1031 exchange, such as related party transactions and cash boot. It's essential to work with a qualified intermediary and consult with a tax professional to ensure compliance and maximize the benefits of a 1031 exchange.

In summary, 1031 exchanges can be a powerful tax-saving strategy for real estate investors, but it's important to understand the rules and regulations that must be followed. By working with a qualified intermediary and consulting with a tax professional, investors can properly execute a 1031 exchange and defer taxes, diversify their investment portfolio, and increase their overall returns.

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How 1031 Exchanges Work

A 1031 exchange is a tax-saving strategy that allows real estate investors to defer paying taxes on the sale of a property by using the proceeds to purchase a similar "like-kind" property. To qualify as a 1031 exchange, the property being sold and the property being purchased must be used for investment or business purposes, this means that primary residences do not qualify for a 1031 exchange.

The IRS has strict rules and regulations that must be followed in order to properly execute a 1031 exchange. One of the most important rules is the 45-day identification period, during which the investor must identify up to three potential replacement properties. The investor must then complete the exchange and acquire one of those properties within 180 days of selling the original property.

Additionally, there are some restrictions on the type of transactions that qualify for a 1031 exchange such as related party transactions, which occur when the buyer and the seller are related and the properties are not considered arm's length transactions. Cash boot, when an investor receives cash or other non-like-kind property as part of the exchange is also not allowed. Mortgage assumptions also need to be considered as well.

The use of a qualified intermediary is necessary during the process of a 1031 exchange. The intermediary holds the proceeds from the sale of the original property and facilitates the purchase of the replacement property, ensuring compliance with IRS regulations. Furthermore, it is important to work with a tax professional to ensure compliance and to maximize the benefits of a 1031 exchange.

In summary, a 1031 exchange can be a powerful tax-saving strategy for real estate investors. By following the rules and regulations set forth by the IRS, investors can defer taxes, diversify their investment portfolio, and increase their overall returns. However, it's important to work with a qualified intermediary and consult with a tax professional to ensure compliance and maximize the benefits of a 1031 exchange.

Traditional Real Estate Sales

In contrast to 1031 exchanges, traditional real estate sales involve the listing, showing, and closing of a property. The process begins with the homeowner hiring a real estate agent to list the property for sale. The agent will then show the property to potential buyers, negotiate offers, and assist with the closing process. Once the sale is complete, the homeowner will receive the proceeds from the sale and will be responsible for paying any taxes on the gain from the sale.

When it comes to taxes, traditional real estate sales can be quite different from 1031 exchanges. The gain from the sale of a property is subject to capital gains tax, which is generally calculated as the difference between the sale price and the cost basis of the property. The cost basis is typically the purchase price of the property plus any capital improvements made during the time of ownership. For example, if an investor bought a property for $200,000 and sells it for $300,000, the gain from the sale would be $100,000 and would be subject to capital gains tax.

Additionally, homeowners may also be subject to state and local taxes on the sale of a property. In some cases, these taxes can be significant and can greatly impact the overall return on a real estate investment.

It's important to note that there are certain situations where traditional real estate sales may be more advantageous than 1031 exchanges, such as when a property has decreased in value or when an investor is looking to liquidate their investment. In those cases, a traditional real estate sale may result in a lower tax bill than a 1031 exchange would.

In summary, traditional real estate sales are a common method of selling a property, but it can come with significant tax implications. Homeowners will be responsible for paying capital gains tax on the sale of a property, and may also be subject to state and local taxes. While traditional real estate sales may be more advantageous in certain situations, it's important to weigh the tax implications against the benefits of a 1031 exchange before making a decision.

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Differences between 1031 Exchanges and Traditional Real Estate Sales

One of the main differences between 1031 exchanges and traditional real estate sales is the way taxes are handled. As discussed earlier, 1031 exchanges allow real estate investors to defer taxes on the sale of a property by using the proceeds to purchase a similar "like-kind" property. In contrast, traditional real estate sales result in the immediate recognition of any gain from the sale, and the homeowner is responsible for paying any taxes on that gain.

Another difference is the flexibility provided by 1031 exchanges. With a traditional real estate sale, the homeowner receives the proceeds from the sale and is then responsible for finding a new investment property, if they choose to do so. In contrast, a 1031 exchange allows the investor to identify replacement properties before the sale of the original property, giving them more control over the reinvestment of their capital.

Additionally, 1031 exchanges can be used in a series of exchanges, allowing the real estate investor to compound the tax-deferral effect over time, which can lead to significant tax savings. Traditional real estate sales, on the other hand, result in immediate recognition of any gain and taxes are paid on the sale of each property.

It's important to note that the Tax Cuts and Jobs Act of 2017 placed some limits on 1031 exchanges and investors should consult with a tax professional to ensure compliance and maximize the benefits of a 1031 exchange.

In summary, 1031 exchanges and traditional real estate sales are two different methods of buying and selling real estate that come with their own set of benefits and drawbacks. While 1031 exchanges can provide significant tax benefits and flexibility, traditional real estate sales may be more advantageous in certain situations. It's important for real estate investors to understand the differences and consult with a tax professional before making a decision.

In conclusion, 1031 exchanges and traditional real estate sales are two different methods of buying and selling real estate that come with their own set of benefits and drawbacks. 1031 exchanges can provide significant tax benefits, flexibility and enable real estate investors to defer taxes, diversify their investment portfolio, and increase their overall returns. However, traditional real estate sales may be more advantageous in certain situations, and it's important for real estate investors to understand the differences and consult with a tax professional before making a decision.

It's important to note that the rules and regulations for 1031 exchanges can be complex and it is essential to work with a qualified intermediary and consult with a tax professional to ensure compliance and maximize the benefits of a 1031 exchange. Additionally, the Tax Cuts and Jobs Act of 2017 placed some limits on 1031 exchanges, so investors should be aware of the current laws and regulations.

1031 exchanges can be a powerful tax-saving strategy for real estate investors, but it's important to understand the rules and regulations that must be followed and consult with a professional before making a decision. With the right strategy and proper planning, 1031 exchanges can be an effective way for investors to defer taxes and increase their overall returns.