Peter decided it was time to increase his investment potential. He planned to sell the 2-bedroom condo he had been renting for 10 years and purchase a triplex or fourplex through a 1031 exchange. In compliance with 1031 exchange regulations, he engaged a qualified intermediary (“QI”) to handle the funds of the condo and the eventual acquisition of the replacement property.
The condo sold for the anticipated price and the transaction went smoothly. Peter then had 45 days in his identification period to identify three potential replacement properties. He found two fourplexes and a triplex that he believed offered him the investment opportunity he desired. Before the 45-day deadline, he notified his QI of his intentions and began the process of acquiring the first property.
Due to competition for the first property and unforeseen circumstances with the second property, Peter was unable to close on either of his first two replacement property choices. By the time Peter knew the first two properties would not be options, there was not enough time remaining in the 180-day exchange period to acquire the third property. Peter had to cancel his exchange and pay the taxes on the capital gains he earned from the sale of his condo. After paying taxes, Peter did not have the cash he had expected and could no longer afford a triplex, much less a fourplex, without obtaining a greater loan amount, decreasing his income potential.
How could Peter have guaranteed a successful exchange?
A Potential Insurance Policy
Delaware Statutory Trusts (“DSTs”) offer 1031 exchange investors a potential insurance policy; a way to ensure (as long as the DST is open) 100% of their exchange funds are invested in a replacement property rather than taxed for capital gains.
Put your insurance policy in place by identifying a property within a DST as your third potential replacement property during your identification period. If you can’t acquire your first two properties or you have remaining funds to invest, you can purchase beneficial interests in the identified DST, which qualifies you as owning a direct interest in the DSTs real estate, satisfying the 1031 exchange requirements.
IF… You’ve acquired a replacement property, but you’re left with extra cash. Perhaps you could not find a replacement property for just the right price to use all of the income from the relinquished property. Maybe the closing costs amounted to less than expected. Whatever the case, if you found yourself with taxable boot, you can still purchase interests in a DST.
IF….You find yourself like Peter and cannot acquire your identified replacement properties within the 180-exchange period for whatever reason you can still purchase interests in a DST as long as there is still a position left large enough for your exchange property.
Interest in real estate owned by a DST can be acquired in as little as three days. Your identification period deadline may inhibit your ability to identify a property you know for certain you will complete the acquisition transaction. But when you have a DST identified (if there is still enough available in the DST) as a potential replacement property, you have a backstop to ensure your exchange closes before it’s too late.
Investing in real estate owned by a DST can be acquired for as little as $25,000. You may have extra funds from the sale of your relinquished property that do not amount to enough to purchase a second worthwhile replacement property, but when you have a DST identified as a potential replacement property, you have a backstop to ensure you can use all of your exchange funds to acquire investment-grade real estate.
Now you can sell your investment properties that have appreciated and lock in the profits without worrying.
Don’t put your 1031 exchange at risk; put a DST insurance policy in place.