A Delaware Statutory Trust (DST) is a single purpose entity commonly used to sell shares of commercial and residential properties, however, these investments are the first known DST transactions in farmland. DSTs represents an annual market of over $3B, allowing investors to use section 1031 exchange funds to acquire equity in target assets. The application of the DST vehicle to farmland investing is exciting, as it allows investors to take direct ownership in an asset class historically requiring capital at a scale that is out of reach for many investors. DST Farms delivers a path for a new class of investors to engage direct ownership in farmland.
As a single purpose entity, DST investment vehicles qualify for section 1031 real estate exchanges providing investors with an opportunity to 1031 exchange into replacement properties without recognizing taxable gain on the sale of previously owned assets. As part of section 1031 exchanges, individual investors receive shares in the DST Trust. The property is owned and professionally managed by the DST Trust and is leased triple net to a single Master Tenant. Income can be distributed monthly, quarterly, or annually. When the DST property is sold, any capital distributions to investors remain eligible for subsequent section 1031 exchanges.
The DST investment vehicle is ideal for section 1031 exchanges due to the following characteristics:
45 day id
DST's eliminate much of the hassle of the identification process by offering investors numerous properties that can be identified immediately.
When a replacement property is lesser in value than the previously sold property, the remaining money must be taxed. This leftover money is known as excess boot. With a DST you can invest down to the penny, ensuring that 100% of your exchange funds are invested.
With a DST the property is already purchased, thus removing any closing risk. This makes a DST a great potential backup in your identification process. Some investors choose to identify a DST as “backup insurance” in the event their other identified properties do not close.
Reasons to Use section 1031
Section 1031 of the Internal Revenue Code provides real property owners with a major tax-deferral and reinvestment opportunity that can be utilized by investors to build long-term growth in their real estate portfolio. Section 1031 establishes a procedure where real property owners may simultaneously realize appreciation from a business-use or investment asset, defer capital gains taxes upon the sale of the asset, and use the equity from the asset to invest in a replacement like-kind business use or investment asset.
The principal advantage of a Section 1031 tax-deferred exchange is the ability to use the entire equity of a property owned by a taxpayer to acquire the replacement property. It eliminates the immediate tax implications of selling real property, thereby allowing property owners to employ their equity into more advantageous real estate positions. If a property owner wishes to continue to invest in real estate, an exchange can be a beneficial alternative to a sale and purchase.
A section 1031 exchange can provide the
following benefits to real estate evestor:
Section 1031 exchanges have two critical timing rules that must be followed for a successful exchange. These are known as the 45-day identification period and the 180-day exchange period. Failure to adhere to these standards will result in an unsuccessful exchange. There are no exceptions or extensions to these two standards. The standards are more specifically described as follows:
45-Day Identification Period Closing of the sale of the property to be relinquished triggers the 45-day identification period. Upon closing of the sale of the relinquished property, the individual completing the exchange has 45 days to identify the replacement properties. If the individual completing the exchange is relinquishing multiple properties, the 45-day identification period commences upon closing of the sale of the first relinquished property.
180-Day Exchange Period The 180-Day exchange period requires closing on one of the identified properties to be completed by the earlier of:
The individual completing the exchange may identify as many as three replacement properties, regardless of their total value. This is known as the “3-Property Rule”. In the alternative, the individual completing the exchange may identify any number of properties provided their aggregate fair market value on the 45th day does not exceed 200% of the aggregate fair market value of all of your relinquished property on the date of its transfer (the “200% Rule”). If the individual complies with these rules, they do not need to acquire all of the property identified.
Deferring all Capital
As a general rule, exchanging taxpayers should keep three important considerations in mind. First, replacement property fair market value must be equal or greater than the fair market value of the relinquished property. Second, all of the exchange proceeds from the sale of the relinquished property must be used to acquire the replacement party. Third, the replacement property debt must be equal to or greater than the relinquished property debt so as to avoid taxable gain due to debt relief.
Not following these rules may result in a taxable gain. These three considerations are mentioned to help exchanging taxpayers' structure a section 1031 exchange. If you do not follow them, you may still do the exchange. However, it is extremely important to speak with your tax advisor regarding the effects of debt relief or receiving cash for personal use.