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A Little-Known Asset Protection Strategy in Estate Planning

When considering asset protection strategies in estate planning, common approaches like trusts, limited liability corporations (LLCs), family partnerships, and insurance often come to mind. However, a lesser known but highly effective strategy for investment property owners is the 1031 Exchange using a Delaware Statutory Trust (DST).

This approach offers significant benefits, particularly when it comes to eliminating capital gains tax upon the owner’s death and ensuring a smooth transfer of wealth to heirs. Here’s an in-depth look at how DSTs can be crucial in estate planning.

Understanding the 1031 Exchange and DSTs

A 1031 Exchange, named after Section 1031 of the Internal Revenue Code, allows investors to defer paying capital gains taxes on the sale of an investment property by reinvesting the proceeds into a like-kind property of equal or greater value. 

A Delaware Statutory Trust (DST) is a legal entity that allows investors to own a fractional interest in high-quality, professionally managed real estate. When combined, a 1031 Exchange using a DST enables investors to defer capital gains taxes while also benefiting from the stability and income potential of commercial-grade real estate. Perhaps most importantly, however, as an estate planning strategy, a 1031 DST exchange can allow an investment property owner to eliminate capital gains liability to heirs upon death completely.

Benefits of Using DSTs in Estate Planning

Step-Up in Basis

  1. Upon the owner’s death, the heirs receive a step-up in basis for the inherited DST interests. This means the property’s value is reset to its current market value, potentially eliminating any capital gains tax liability for the heirs when they decide to sell.

Passive Income Generation

  1. Investors in DSTs receive regular income distributions without property management responsibilities. This is particularly beneficial for those looking to simplify their estate and provide a steady income stream for their heirs.

Tax Deferral with 1031 Exchanges

  1. By utilizing a 1031 Exchange, investors can defer capital gains taxes, allowing more of their wealth to be reinvested and grown over time. This deferral can continue indefinitely as long as the exchange requirements are met.

Simplified Asset Distribution

  1. DSTs offer a straightforward way to distribute assets to beneficiaries. Each heir can receive their proportional share of the DST without the complexities of dividing physical property, making the estate administration process smoother and more efficient.

Accelerated Wealth Building

  1. The combination of tax deferral, access to high-quality properties, and professional management can accelerate wealth building. Heirs inherit a well-structured portfolio that continues to generate income and appreciates over time.

Case Study: The Smith Family

Let's consider the Smith family to illustrate the effectiveness of using DSTs in estate planning. A successful real estate investor, John Smith owns several investment properties worth $10 million. As John approaches retirement, he decides to simplify his estate and ensure a seamless transfer of wealth to his two children.

Initial Situation:

  • John’s properties have appreciated significantly, resulting in a potential capital gains tax liability of $2 million if sold.
  • John wants to maintain a steady income stream and avoid the complexities of property management in his later years.

The Strategy:

  1. John sells his investment properties through a 1031 Exchange, reinvesting the proceeds into multiple DSTs.
  2. By doing so, he defers the $2 million capital gains tax, allowing him to reinvest the full $10 million into institutional-grade real estate.
  3. The DSTs provide John with passive income, ensuring a stable financial future without the hassles of managing properties.

Upon John’s Passing:

  • John’s DST interests are passed to his children.
  • The DSTs receive a step-up in basis, effectively eliminating the deferred capital gains tax.
  • John’s children inherit a diversified real estate portfolio, providing them with ongoing income and potential for future appreciation.

Outcomes:

  • The Smith family successfully avoids a $2 million capital gains tax liability.
  • John’s children receive equal shares of a well-structured, income-generating real estate portfolio.
  • The estate distribution process is simplified, and the family’s wealth is preserved and grown for future generations.

Conclusion

The 1031 Exchange using a Delaware Statutory Trust (DST) is a powerful yet often overlooked strategy in estate planning. By leveraging this approach, investment property owners can defer capital gains taxes, provide passive income for their heirs, and ensure a smooth and efficient transfer of wealth. As the Smith family case study demonstrates, DSTs offer significant benefits that can enhance and protect your estate transition plans.

Please note that investing in real estate and 1031 exchange replacement properties, including DSTs, may not be suitable for all investors and may involve significant risks, and the potential for partial or total loss of principal. These risks include, but are not limited to, lack of liquidity, limited transferability, conflicts of interest and real estate fluctuations based upon a number of factors, which may include changes in interest rates, laws, operating expenses, insurance costs and tenant turnover. Investors should also understand all fees associated with a particular investment and how those fees could affect the overall performance of the investment. DSTs are also susceptible to changes in the IRS's treatment of tax-deferred exchanges.

For more information on how DSTs can benefit your estate planning strategy, contact our team today.  We specialize in helping accredited investors navigate the complexities of 1031 exchanges and DST investments.

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Paul Getty

Paul Getty is a licensed real estate broker in the state of California and Texas and has been directly involved in commercial transactions totaling over $3 billion on assets throughout the United States. His experience spans all major asset classes including retail, office, multifamily, and student, and senior housing. Paul’s transaction experience includes buy and sell side representation, sourcing and structuring of debt and equity, workouts, and asset and property management. He has worked closely with nationally prominent real estate brokerage and investment organizations including Marcus Millichap, CB Richard Ellis, JP Morgan, and Morgan Stanley among others on the firm’s numerous transactions. Paul also maintains a broad network of active buyers and sellers of commercial real estate including lenders, institutions, family office managers, and high net worth individuals. Prior to founding First Guardian Group/FGG1031, Paul was a founder and CEO of Venture Navigation, a boutique investment banking firm specializing in structuring equity investments made by institutions and high net worth individuals. He possesses over 35 years of comprehensive worldwide business management experience in environments ranging from early phase start-ups to multi-billion-dollar corporations. His track record includes participation in IPOs and successful M&A activity that has resulted in investor returns of over $700M. Paul holds an MBA in Finance from the University of Michigan, graduating with honors, and a Bachelor’s Degree in Chemistry from Wayne State University. Paul Getty holds Series 22, 62, and 63 securities licenses and is a registered financial representative with LightPath Capital Inc, member FINRA /SIPC. Paul is a noted speaker, author, and actively lectures on investments, sales, and management related topics. He is author of The 12 Magic Slides, Regulation A+: How the JOBS Act Creates Opportunities for Entrepreneurs and Investors, and Tax Deferral Strategies Utilizing the Delaware Statutory Trust (DST), available on Amazon and other retail outlets.

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