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DST as a 1031 Exchange8 Reasons to Use a DST for a 10311031 Exchanges - FAQsQualified IntermediaryProcedural Outline
Generally, Section 1031 of the Internal Revenue Code of 1986, as amended (the “Code”), provides an alternative strategy for deferring the capital gains tax that may arise from the sale of a property.
By exchanging a relinquished property for “like-kind” real estate, as defined below, property owners may defer their federal taxes and use all of the proceeds for the purchase of replacement property.
Whether any particular transaction will qualify under Section 1031 depends on the specific facts involved, including, without limitation: the nature and use of the relinquished property and the method of its disposition; the use of a “qualified intermediary” and a qualified exchange escrow, as discussed below; and the lapse of time between the sale of the relinquished property and the identification and acquisition of the replacement property.
Set forth below are some examples of “like-kind” real estate:
It is important to note that one’s primary residence, as well as vacation or second homes held primarily for personal use, will not qualify for a Section 1031 exchange. However, there are certain safe harbors for vacation and second homes to qualify as either a “relinquished property” or a “replacement property.”
In accordance with the Internal Revenue Service’s Revenue Ruling 2004-86, a beneficial interest in a Delaware statutory trust, or “DST,” that holds a replacement property may be considered “like-kind” replacement property in a Section 1031 exchange. A DST may own one or more properties.
The rights and obligations of investors in a DST will be governed by the DST’s trust agreement. Typically, investors have limited voting rights over the operation and ownership of any properties owned by the DST. In addition, the trustees of the DST may be entitled to certain fees and reimbursements, as set forth in the applicable trust agreement.
A Qualified Intermediary, or “QI,” is a company that is in the full-time business of facilitating Section 1031 tax-deferred exchanges. The role of a QI is defined in Treasury Regulations. The QI enters into a written agreement with the taxpayer where QI transfers the relinquished property to the buyer, and transfers the replacement property to the taxpayer pursuant to the exchange agreement. The QI holds the proceeds from the sale of the relinquished property in a trust or escrow account in order to ensure the taxpayer never has actual or constructive receipt of the sale proceeds.
A Qualified Intermediary may also be known as an Accommodator, Facilitator or Qualified Escrow Holder. Certain persons, including those who have acted as the exchanger’s employee, accountant, attorney, investment banker or broker or real estate broker within the two year period preceding the sale of the relinquished property, will be specifically disqualified from acting as a Qualified Intermediary.
This is a summary of some of the key guidelines for a transaction under Section 1031, but this is not an exhaustive list. The costs associated with a Section 1031 exchange may impact the returns and may outweigh the tax benefits of the transaction. Each prospective investor must consult his or her own tax advisor regarding the qualification of a particular transaction under Section 1031.
Property identification is done through the Qualified Intermediary. The replacement property must be identified in a written document, known as an “Identification Notice.” The requirements for a property Identification Notice are as follows:
An identification of replacement property may be revoked prior to the end of the identification period. The revocation must be in writing, signed by the exchanger and delivered to the same person to whom the original Identification Notice was sent. No changes or revocations may be made to the Identification Notice after the end of the identification period (45 days).
The exchanger may identify multiple replacement properties. There are certain additional rules to keep in mind, including the following:
In addition to the objective of deferring capital gains tax, there may be other benefits to participating in a Section 1031 exchange:
Vacation or second homes held by the exchanger primarily for personal use do not qualify for tax deferred exchange treatment under Section 1031.
The safe harbor for a vacation or second home to qualify as relinquished property in a Section 1031 exchange requires the exchanger to have owned the property for twenty-four months immediately before the exchange, and within each of those two twelve-month periods the exchanger must have:
For these purposes, “personal use” includes use by the exchanger’s friends and family members that do not pay fair market value rent.
Yes. For an exchange to satisfy Section 1031, the taxpayer that will hold the title to the replacement property must be the same taxpayer that held title to the relinquished property. However, business considerations, liability issues, and lender requirements may make it difficult for the exchanger to keep the same vesting on the replacement property. Exchangers must anticipate these vesting issues as part of their advanced planning for the exchange.
There are some exceptions to this rule when dealing with entities that are disregarded for federal income tax purposes. For example, the following changes in vesting usually do not destroy the integrity of the exchange:
As a general rule, the exchanger should not make any changes in the vesting of the relinquished or replacement properties prior to or during the exchange. Exchangers are cautioned to consult with their tax or legal advisors regarding how their vesting issues will impact the structure of their exchange before they transfer a relinquished property.
Section 1033 of the Code covers “involuntary conversions,” including natural disasters and losses via eminent domain. Property owners may not realize that funds received as a result of these actions – condemnation award proceeds or insurance proceeds – would normally trigger recognition of gain. Section 1033 of the code, similar to Section 1031, allows taxpayers to defer that recognition of gain.
While similar to a Section 1031 exchange, Section 1033 has some notable differences:
The information contained herein is neither an offer to sell, nor the solicitation of an offer to buy any security in any program sponsored by IDEX Financial Group, which can be made only by the investment-specific Private Placement Memorandum. Any representation to the contrary is unlawful.
The information contained herein is a brief and general description of certain guidelines regarding Section 1031 exchanges. All prospective investors should consult with their own tax advisors regarding an investment.