For the past few weeks, we’ve been discussing the many benefits DSTs offer investors who are thinking about using a 1031 Exchange for a replacement property. Here’s another benefit that can motivate current business property owners to consider selling and reinvesting using a DST.
Consider the hypothetical case of John and Mary Thompson and how they were able to capture the trapped equity in their rental home and put it to work in a DST while also boosting their investment income three-fold.
Let’s assume that John and Mary bought a Bay Area home in 1980 for a whopping $125,000. As their family grew, they moved to a new home but kept their original house and rented it for income purposes. That house was valued at $1,400,000 in 2018, which meant, if the wanted to sell, they would realize nearly $1,300,000 in equity (after closing costs).
The rent they’d been receiving from the property provided approximately $20,000 in annual pre-tax cash flow after all expenses. Having exhausted the depreciation benefits allowed by current tax law, however, they had been receiving even less after-tax income.
At a personal level, John and Mary wanted to begin enjoying their free time and travel more, and the maintenance and upkeep burdens of their rental home had prevented them from doing so. They felt trapped. Fortunately, their financial advisor provided them with several options to consider in helping them accomplish their objectives with their changing lifestyle.
After careful evaluation, they decided to sell their rental property and complete a 1031 Exchange, moving their sales proceeds into a small portfolio of DST properties that included net leased single-tenant retail properties and class A multifamily assets. With this investment, Mary and John gained the added benefit of owning a diversified portfolio of institutional-grade real estate without the headaches and late-night calls associated with hands-on management.
Better yet, with the tax-deferred benefits of their DST, they were able to utilize the full power of the equity they captured from the sale of their investment property and began to realize net annualized cash flow of 5%+ as a percentage of their invested equity, which delivered approximately $75,000 in income that was partially tax sheltered. That’s more than three times the rental income they received from their previous property.
By unlocking the trapped equity from their income property and putting it to work within a DST, their new portfolio of real estate investments generated a higher amount of recurring income and provided them with more time to enjoy their next phase of life.
Similar to traditional real estate investments, note that DSTs carry certain risks. They are subject to market risks and should be considered as long-term generally illiquid investments. Returns are not guaranteed and all major property decisions including when to sell are determined by the trustee and not the individual investor. DSTs are securities and can only be purchased by accredited investors* through properly licensed securities representatives.
The fees and expenses associated with DSTs can partially offset the benefits of 1031 tax deferral and that investors should read and understand all the risks and other disclosures in the offering materials for any investment they are considering.
For more information, feel free to reach out to contact us.
*Accredited investors must have a minimum net worth of $1 million or greater excluding their personal residence or have annual income of $200,000 or greater if single or $300,000 if married.