At 1031 Crowdfunding, we always strive to define the commonly used, but not-often-explained details of Delaware Statutory Trusts and 1031 Exchanges. Today we will look at Holding Periods.
A holding period is simply the period of time one owns an asset before disposing of it. The holding period begins on the day after the asset is acquired and concludes on the day the asset is disposed. The holding period of any capital asset is significant to many aspects of owning that asset, so it is essential to know your holding period and how that period will affect your investment goals.
Why hold an asset for an extended period?
Investors may hold an asset for an extended period so that they are taxed on the profits at capital gains tax rates rather than regular income tax rates. An asset held for less than one year will incur ordinary income taxes. An asset held for one year and a day or more will incur long-term capital gain taxes. Understanding your holding period and the differences between these two tax rates prior to disposing of an asset will help you determine if the holding period of your asset was short or long enough to meet your objective.
DST Holding Periods and Real Estate Securities
For private equity funds, including DSTs, a general holding period could be 5-7 years, which allows the real estate asset or assets to generate enough income and build enough value to meet the investment objectives of the security. In the event that investment objectives are achieved prior to completing the estimated holding period, fund managers will typically sell the assets and return the earned income to the investors, shortening the holding period. In contrast, if the investment objectives are not met within the estimated holding period, fund managers will typically extend the holding period to allow more time to achieve the desired yields.
Another consideration for fund managers when determining when to extend or shorten a holding period is the market. A rising market is an ideal time to sell real estate. While the peak of the market would provide the highest returns on the investment, it is impossible to determine precisely when the peak will occur, and, waiting for the market to peak, increases the risk that buyers will leave the market to avoid the highest prices and the market will begin to decline.
Some real estate investments are better suited for longer holding periods that could last 10, 20, or 30+ years. These holding periods could suit those investors who are looking for a stable income rather than trying to build wealth. If the investor finds a stable property that will produce income for an extended period of time, that investor should plan on a long-term holding period. Another situation that justifies a long-term holding period is an investment in a property that has a land lease, or ground lease. In the case of a land lease, where the investor is considered a tenant and pays rent to use the land on which his or her investment property or business is located, that investor will probably want to make the most out of the additional capital and efforts spent to adapt the land to meet the investor’s needs. Such investments are often made more for the income produced rather than the gains received upon the sale of the investment; therefore, the longer holding period is usually preferable.
The duration of the hold, whether a general 5-7 years, a shorter 3-5 years, or a longer 10 or more years, should be considered when investing in any security to help you determine whether or not the fund will align with your individual investment goals.