Nationwide’s eighth annual Advisor Authority Survey reported in October 2022 that investor and advisor concerns mirrored the levels seen at the height of the pandemic. The top four concerns driving such a low level of future optimism are volatility, recession fears, inflation, and taxes.
As an advisor, you can do little to insulate clients from the first three concerns. But you have two powerful tax-advantaged investment strategies to help clients tackle their worries over taxes: Delaware statutory trusts and Qualified Opportunity Zone funds.
Delaware statutory trusts (DSTs) and Qualified Opportunity Zone (QOZ) funds are tax-advantaged investment solutions that continue to gain broad appeal among investors intent upon deferring capital gains. Unfortunately, many advisors are unfamiliar with these investments or don’t have sufficient knowledge of how they work to introduce them to their clients.
This creates an opportunity for the advisor who chooses to become familiar with these strategies -- adding a few more arrows to their quiver. This discussion highlights the key differences between DSTs and QOZs and helps identify the types of clients they might be most suitable for.
The DST
The DST is an investment strategy commonly used by investors selling real estate investment property using a 1031 exchange, an Internal Revenue Code section that has been in effect for more than 100 years. Many investment property owners view it as one of the greatest generational wealth-building tools.
By selling investment property and reinvesting the proceeds in “like-kind” replacement property within the applicable timeframes, taxpayers can defer capital gains tax and depreciation recapture for as long as they remain invested. The term like-kind is a broad definition that allows investors to exchange a property like a multifamily housing asset for a self-storage facility, student housing development or even raw land.
The DST comes into play because it is a securitized investment structure that allows 1031 exchangers to own fractional interests in institutional quality commercial real estate property or a portfolio of properties. If structured properly, interests in a DST also qualify as a like-kind replacement property under Internal Revenue Code guidelines. An especially attractive structure to investment property owners who are no longer interested in managing their properties, the DST can offer investors a passive investment structure with a host of additional advantages.
The QOZ
The Qualified Opportunity Zone program was signed into law as part of the 2017 Tax Cuts and Jobs Act. It allows investors to defer capital gains tax on the sale of virtually any asset, not just real estate, unlike a 1031 exchange. In other words, investors can defer taxation on gains realized by selling stock, art, cryptocurrency, a business, and more.
There are more than 8,700 QOZs throughout the U.S. The U.S. Treasury has designated these locations as economically distressed communities in need of development to aid in revitalization. QOZ funds, the investment vehicle required to access QOZ developments, can invest in businesses, real estate, and other assets.
Differences and Similarities
A critical difference between the two strategies is the type of asset that is sold to generate gains. A DST investment via a 1031 exchange only allows tax deferral on the sale of real estate investment property. In contrast, QOZ funds allow tax deferral on almost any asset type, including stocks, bonds, art, jewelry and more.
Another key difference is the fact that DST 1031 exchange investors can continue deferring tax on gains as long as they remain invested, which often happens as they continue using additional exchanges in the future. QOZ fund investors, on the other hand, can only defer taxes on the original capital through December 31, 2026.
Another difference is that when a DST investor passes away, their estate must recognize all gains realized while investing using 1031 exchange strategies. QOZ fund investors who remain invested in the fund investment for at least ten years or until it liquidates, whichever comes first, may have the added benefit of eliminating capital gains tax on any appreciation in the QOZ fund.
Client Profiles – Investing for Income or Capital Appreciation
Each investor’s objectives and goals are unique. Your clients who own real estate investment property and are interested in sustaining a regular income stream will likely be most interested in the DST 1031 exchange strategy.
Clients interested in deferring capital gains tax on selling real estate or other assets are those better suited for QOZ fund investments. And since many QOZ projects are development-oriented and may not provide income for several years, clients who are more attracted to long-term capital appreciation will likely be those most interested in QOZ funds.
Your Opportunity
We encourage you to visit The Inland Academy for additional resources on these two investment strategies. And feel free to also view our current offerings by accessing our Due Diligence Marketplace. Your clients can benefit greatly by you becoming knowledgeable about QOZ funds and DST 1031 exchanges - and you may be able to grow your practice at the same time.
