The coronavirus has thrown almost every aspect of the economy into uncertainty including the real estate market which faces especially heightened challenges. Double-digit unemployment rates have renters scrambling to make their monthly payments and in turn caused landlords to be stressed about losing a once reliable income stream. Add to the mix millions of Americans now working from home, no one knows what the future of the traditional office and retail sectors will look like whenever the virus is under control.
With so many unknowns, now may be the right time to diversify your real estate holdings, specifically by using the Delaware Statutory Trust (DST) structure with a 1031 Exchange. A DST may help you avoid having all your eggs in one basket by turning a single holding into multiple properties, all while deferring capital gains taxes, resetting the depreciation clock, and aligning your portfolio with your investment goals.
Why Diversification and Why Now?
Diversifying your real estate holdings with a DST is made possible by the ability to own different segments of the market, in different locations, and even by taking a single property and turning it into multiple properties. While diversification does not guarantee profits or avoidance of losses, you could potentially participate in the upside of different areas of the market while also having some downside protection if a single area of the market suffers more in this current downturn.
Keep Your Eye on Your Goals
While a buy-and-hold strategy may work for the stock market, it could potentially limit your real estate investment benefits, or worse, expose you to economic setbacks that some landlords are experiencing today. If you own a rental house for which you have paid off the mortgage and have steady monthly cash flow from a dependable tenant, there may be little incentive to relinquish such dependability.
However, as the Covid-19 pandemic has shown us, even the most reliable investments can get upended by events beyond your control and that is why it might make sense to evaluate other investment options. For example, a DST investment can help you turn that single-family rental property into fractional ownership of two or more multi-family properties located in different areas of the country. That provides a level of diversification that has the potential to help protect your income stream.
Reset the Depreciation Clock
It is possible a long-term rental property may no longer allow you to maximize depreciation, so swapping it for different properties resets the depreciation clock. There are complexities involved with depreciation related to 1031 Exchanges, so depending on your situation, you should seek assistance from your CPA or financial professional to determine the best approach to calculating depreciation related to your individual transactions.
The simplest approach allows you to start fresh, with a residential property depreciating over 27.5 years and a commercial property depreciating over 39 years. It is also possible, and maybe advantageous, to separate the schedules to depreciate your cost basis from the first property on the original timeline and fully depreciate the remaining cost basis on the replacement property.
Here again, the DST offers a distinct advantage. Upon the death of the DST owner, no depreciation tax (or capital gains tax) obligations are passed along to the heirs. This enables you to apply a powerful estate planning strategy in a time when so much uncertainty remains around the timing and effectiveness of a vaccine.
1031 Exchange Under Threat from Politicians
Mounting deficits and unbridled spending are putting significant pressure on politicians from both sides of the aisle to further compromise or even eliminate 1031 benefits for landlords.
In 2017 Republicans including Paul Ryan and Mitch McConnell floated proposals that eventually led to the elimination of 1031 benefits formerly permitted for personal and business property.
As recently as this July 2020, Joe Biden proposed eliminating 1031 Exchange benefits for investors reporting greater than $400,000 in annual income in order to partially fund more government payments to select groups.
As if current eviction prohibitions for non-paying tenants are not enough, rental property owners are being put in the cross hairs of schemes to further squeeze them with added taxes to pay for government redistribution programs.
Time to Act
Real estate remains an integral part of millions of investors’ portfolios. And while investment property owners may be struggling to know what to do in this current environment, a DST can help provide important diversification, depreciation, and estate planning benefits in the COVID virus era.
Please note that that investments in DSTs, as in most traditional rental properties should be regarded as generally illiquid and related costs, potential losses, and lack of control may outweigh the benefits of tax deferral and anticipated income and appreciation. Furthermore, there are important differences between DSTs including sponsor history and track record, asset type, location, etc. that need to be evaluated with the assistance of an experienced firm such as First Guardian Group.
For more information on 1031 Exchanges and replacement property options please feel free to contact us at email@example.com or you can also schedule some time on Paul’s calendar here for a personal consultation.