The current environment is disrupting many 1031 exchanges, but DSTs offer solutions
Here’s the scenario. After receiving that fantastic offer that you hoped to get on your investment property, you have closed on your sale. Congratulations! And because you’re executing a 1031 exchange, you’re able to defer the capital gains tax that would have applied to your property’s appreciation in value. Now you just need to find your replacement property and you have 45 days to do that.
But wait. The current environment has disrupted everything, making it difficult to meet the strict 45-day “replacement property identification period” requirement necessary for a successful 1031 exchange transaction. Here’s why:
- Viewing properties is limited. With stay-at-home orders and lockdowns across the country and some states identifying real estate as a non-essential service, you may not be able to view replacement properties within the necessary timeframe.
- Inspecting properties may be on hold. The same challenge impacts inspecting potential replacement properties as does viewing properties. In addition, inspectors be denied access, or they may not want to risk exposing themselves to the virus.
- Securing financing is slowed. The exchange process requires that you replace the debt you had on your relinquished property with an equal amount of financing (or financing plus additional cash) on the new property. But with the financial system in crisis and the potential for loan defaults, lenders may not be as responsive to your needs as they otherwise would be.
Several industry groups recognized these challenges early as the pandemic started to grow and began lobbying the Treasury Department and the Internal Revenue Service (IRS) to delay the deadlines on 1031 exchanges that are currently in process. These groups included the Alternative & Direct Investment Securities Association (ADISA), the National Association of Realtors and the Institute of Portfolio Alternatives (IPA). The IRS issued Notice 2020-23, which extends 1031 deadlines for certain Section 1031 exchanges to July 15, 2020. As a result of this Notice, if a deadline under a 1031 exchange transaction falls after March 31, 2020 and before July 15, 2020 the deadline to complete the transaction has been extended to July 15, 2020.
Delaware Statutory Trusts to the Rescue
Fortunately, there is an answer for both time-constrained 1031 exchangers who have already sold an investment property and potential exchangers who are under contract but have not yet closed. Delaware Statutory Trusts (DSTs) can help investors in two different ways.
First, a DST could serve as a back-up option in the event a 1031 exchanger is not able to find a suitable replacement property in time (due to one or several of the challenges noted above). If they can close on their original choice of a replacement property, great. If not, the DST would allow the investor to successfully complete the exchange on time and preserve their tax deferral benefits.
Second, the DST could be the original preference for the exchanger who is simply tired of the responsibilities of managing their own investment property. The DST structure allows this 1031 exchanger to either select a single property or create a diversified portfolio of different property types in different geographical areas.
Perhaps the greatest value a DST offers is its ability to help avoid many of the challenges that current 1031 exchangers may be facing. Because a DST already owns the property or properties, the due diligence, valuation and inspection have already been completed. The management team is already secured. The lending is already in place, so securing debt isn’t necessary. And, for the 1031 exchanger who happens to be right up against their 45-day window, a DST investment can typically be closed in less than 72 hours.
If you are considering a 1031 exchange or are already in the process of executing one, we encourage you to talk to your financial representative and a Qualified Intermediary about a DST investment. In times of crisis, so many unforeseen events can befall investors. A DST may be just the right solution for exchangers who are at risk of losing their tax-deferral benefits due to no fault of their own.