Most DST investors spend their time evaluating the property. Far fewer think about what happens when the property is sold.
Richard invested in a 1031 DST eight years ago. Then one day, he received an email from the sponsor. The property was under contract to be sold.
He wasn’t involved in negotiating the sale or deciding when to sell. He had notice of the pending sale, a preliminary closing statement, and decisions to make about what he would do next.
With some preparation, the process can be straightforward. Here’s what happens when a DST property is sold and what investors should know ahead of time.
What to Expect Before and After the Sale
Investors typically are not involved in negotiating the sale or attending the closing. You may hear from the sponsor through a quarterly update or other communication that the property is being marketed or a sale is being considered.
Before closing, the sponsor should provide an estimate of your share of the sale proceeds and outstanding debt on the property, if any. After the sale closes, the final closing statement shows the sale price, closing costs, debt payoff, and your share of the remaining proceeds.
If you want to complete another 1031 exchange, contact your tax advisor and qualified intermediary (QI) as soon as a sale is under discussion. Your 45-day identification period begins when the sale closes.
How Are the Sale Proceeds Distributed?
When the DST property sells, proceeds first cover expenses, outstanding debt, and other obligations.
The remaining proceeds are then distributed to investors according to their ownership interests and the terms of the investment.
Your final proceeds depend on:
- The property’s sale price
- Outstanding debt
- Selling expenses
- Other transaction costs
- Your ownership interest
Can You Do Another 1031 Exchange?
Yes, if the transaction is structured properly, you can reinvest the proceeds into another qualifying replacement property and continue deferring your gain, if any.
A 1031 exchange gives you 45 days after the sale of the relinquished property to identify replacement property and 180 days to complete the exchange.
To defer the full gain, the replacement property should carry at least as much equity and at least as much debt as the property that was sold. Any cash you receive or proceeds you do not reinvest may be taxable, often referred to as “boot.”
If You Exchange Again, Check Your Depreciation Schedule
If you complete another 1031 exchange, your basis in the old property generally carries over to the new replacement property.
Make sure your accountant is aware of the DST rollover and that the replacement property is properly reflected on your tax return and depreciation schedule. This helps keep your records and tax reporting up to date.
What If You’d Rather Just Take the Cash?
You are not required to continue exchanging forever. Some investors choose to take their proceeds and pay the applicable taxes because they need liquidity, their goals have changed, or they simply want to reduce their exposure to real estate.
Any taxable gain that is not deferred through a qualifying exchange may be subject to tax in the year of the sale.
Your tax exposure, need for liquidity, estate plans, and investment objectives can all play a role in that decision.
What About a 721 Exchange or UPREIT?
Some DSTs offer an optional exit into a REIT through a Section 721 transaction. A properly structured 721 contribution may allow an investor to defer recognition of gain while exchanging the DST interest for operating partnership (OP) units. It may also provide potential liquidity and diversification.
The trade-off is that you no longer hold an interest in the underlying real property, and a future sale of the OP units or shares is taxable.
A 721 option is not available with every DST. If it is important to you, confirm that it is part of the offering and discuss the potential benefits and trade-offs with your advisors.
Key Takeaways
- A DST’s projected holding period is an estimate. The sponsor generally controls the timing of the property sale.
- Sale proceeds are reduced by outstanding debt, selling costs, and other applicable expenses before the remaining proceeds are distributed to investors.
- If you’re thinking about another 1031 exchange, involve your qualified intermediary before the sale closes.
- 1031 exchange rules allow 45 days to identify replacement property and 180 days to complete the exchange.
- If you complete another 1031 exchange, make sure your accountant properly reflects the replacement property and depreciation on your tax return.
- A 721/UPREIT option may provide another exit strategy, but it has important tax and investment considerations and is not available with every DST.
The Bottom Line
Richard called his advisor the day that email arrived, not the day the closing statement did. That gave him weeks to weigh his options instead of days. By the time the sale closed, his decision about what to do next was already made.
Investing in a 1031 DST isn’t just about the property you invest in. It’s also about understanding what your options may be when that investment ends. No two exits look the same, and the appropriate choice depends on your own tax position and goals at the time.
Have questions about DST investments?
NexTrend Securities works with accredited investors, providing DST investment options as replacement property in a 1031 exchange.
Call NexTrend Securities at (972) 661-1283
This article is provided for general educational purposes only and does not constitute tax, legal, or investment advice. DST investments involve risk, including illiquidity and potential loss of principal, and are suitable only for accredited investors. Tax treatment depends on individual circumstances. Consult your tax advisor regarding your individual situation. NexTrend Securities is not a tax advisor and does not provide tax advice.