What to Expect in Returns When a DST Goes Full Cycle

Wally Smith:
When one of these things ends, we call it going full cycle, what should somebody expect? They have a DST, one of the pieces that we have is a resource for people to understand, okay, I bought it, now what’s the care and feeding of this thing? What do I have to do? The first year that it’s end of January or they’re ready to file their taxes and they don’t have any information yet? Why hasn’t it arrived yet? We then explain how, I think almost all if not most of these are audited each year.
That takes a while. They can’t complete an audit by December 31st. There are things to need to know, they’re not bad, it’s just information. Many CPAs don’t know how to spell DST. And so we have a sister company that’s a tax and accounting firm and are happy to help them with that, help them understand that. So full cycle, somebody owns one, they’ve been receiving their monthly income, this is great. They get a little bump perhaps depending upon how the deal is structured, and it’s four or five years down the road and they get a notice from the company that what’s going to happen.

Jeff Hertz:
Right. Right. The sponsor has found an opportunity to sell the asset. I think that’s another good question when it comes to doing due diligence on a sponsor is what is the business plan? Hope is not an investment strategy, as they say. So if it’s a multifamily asset, is it a situation where they’re going to put capital into the property to improve it? How are they going to raise rents? What is the business plan? Because ultimately, if the property never grows and the market doesn’t move in your favor, then an exit strategy becomes much more challenging to achieve. Typically 60 to 90 days prior to the close of the sale, notifying the investors, notifying them about when they’re going to be receiving their proceeds, because they’re going to go then start the whole process over again, notify the qualified intermediary, have an account set up, and obviously have replacement property options set up to take those assets.
It’s a good problem to have. We’ve seen a lot of it in the last several years in our industry. But I think it’s also, it’s one component of the experience of being in a DST. It can also be capital preservation, and of course income. Most DSTs obviously provide income, not all of them do.

Wally Smith:
Well, that’s another difference with the TIC, again, to get that sold. Maybe it happens, maybe it doesn’t. A lot of our investors are accustomed to two long term holds. Real estate people are different. They don’t expect the stock market liquidity. But they also would like to know, well, what’s the end game on this? When is this going to happen? And being able to know that, well, at some point in the time you have another 1031, you own a piece of real estate. It just happens to be a fractional piece. It’s securitized. But when it sells, it’s as if you just sold the condo again and now you have choices. You can do a full 1031, you can do a partial, take some boot, take some money back out of it. Those are great opportunities, and that’s what we’d really try to do is teach. We spend so much time teaching, how do these things work?

Jeff Hertz:
And also to recognize that the tax liability that you had five, 10, 15, 20 years ago in terms of that deferral that you’ve been enjoying by doing the 1031 exchange, that’s all going to continue. And in some cases, you may have additional capital gains as well as additional depreciation recapture. The rationale for doing another 1031 exchange in the future might be even greater than it was originally when you got into this process. Unfortunately the only way to truly get a step up in basis is to pass away or swap till you drop, as we say. So in many cases it’s more about just keeping that investment intact and continuing to defer the taxes.

Wally Smith:
Now after generally, again, no bright lines, but if you did have an LLC, there was a family corporation that owned a property, did a 1031, I think it’s safe to say most tax advisors will tell you that after two years is a fairly safe period of time, because life happens, people’s plans change. And so if you had that after about two years, you could make a change, you could break that out, change the ownership, make it a partnership or joint tenants or tenants in common.

Jeff Hertz:
Retitle it. Absolutely

Wally Smith:
Retitle it however you want. And the sponsors will help with that. They’ll get some paperwork fees, but otherwise it’s can be very helpful with estate planning.

Jeff Hertz:
Yeah. Because there’s huge differences between revocable, irrevocable trust, charitable trust, there’s a whole lot of things, but we do see people that maybe they own the asset as an individual and they want to move it into their trust. As you said, just having appropriate guidance from tax professionals can be very helpful.