These Three Forces Will Ensure 1031 Exchanges and Delaware Statutory Trusts Are Here to Stay

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It doesn’t seem that long ago when the winds around the commercial real estate industry were rustling with whispers of the Biden administration’s plan to repeal existing 1031 exchange laws and create alternate types of exchange vehicles such as Delaware Statutory Trusts. However, when Congress passed anti-inflation law With no proposed changes to Section 1031 of the Internal Revenue Code, three powerful forces have fueled the reality that 1031 exchanges and Delaware statutory trusts are here to stay.

What is a Delaware Statutory Trust and How Does It Connect to 1031 Exchanges?

A Delaware Statutory Trust (DST) is a real estate ownership structure for 1031 exchanges that allows multiple investors to hold an undivided beneficial interest in a trust. The term “beneficial interest” means that investors hold a percentage of ownership, and no one owner can claim exclusive ownership over any specific aspect of real estate.

DST’s laws allow the trust to hold title to one or more investment properties which may include commercial, multifamily, pure leasehold, retail, office, industrial, self-storage, etc. Investors are keenly interested in DSTs because the IRS blessed them to qualify as “same-type” investment property for the purposes of a 1031 exchange.

Currently, there has never been an appeal for 1031 exchange strategies such as DST. Strong. According to Mid-Year 2022 Market Update Report from real Estate Research Firm Mountain Dale—In 2021, Secures 1,031 Exchange Programs, Including DST, raised a record $7.4 billion – double the previous record of $3.7 billion Billion set in 2006. According to the same report, DST is ready for the market Keep on growing.

What drives the popularity of 1031 exchanges and similar types of investment strategies as DST? We believe that there are three major forces driving the popularity of DST for 1031 exchanges now and in the near future, and it is expected that these same forces will make it less likely that Congress will pass legislation under existing exchange laws. Will pull the rug.

Force One: Demographics

Demographics are one of the most fundamental forces helping to protect the 1031 Exchange market. According to the US Census Bureau, baby boomers hold more real estate wealth than any other generation in history. born between 1946 And 1964, the impact of the Baby Boomers on all things real estate cannot be underestimated.

For example, Americans over the age of 55 own 53.8% of all real estate in the United States, which includes trillions of dollars in super-wealth. Real estate investment appreciated. Now, many of these aging baby boomers (the oldest of whom will turn 76 this year) are increasingly relinquishing their investment assets through 1031 exchanges. Furthermore, they are looking for alternative real estate investment options that offer tax deferrals and other life-enhancing benefits. more than In addition, this group of aging baby boomers is setting up Delaware statutory trusts for their 1031 Exchange to defer your capital gains taxes and enter a passive investment structure.

Force Two: Pandemic

Another powerful force that helped ignite the popularity of 1031 exchange laws was Covid-19 and its impact on rental property owners. Because our firm works actively with thousands of commercial property owners across the country, we heard firsthand about some of the challenges and pressures property owners faced (and continue to face) during the pandemic. These include mandatory eviction moratoriums, strict rent-control laws and other regulations that directly affect the financial health of real estate investing.

Now, many of these investors are shying away from the financial burden brought on by Covid and the headaches associated with “tenants, toilets and garbage”. Thousands of investors are exiting their rental real estate and reinvesting the proceeds in other real estate opportunities such as 1031 exchanges and Delaware statutory trusts.

Without the ability to defer capital gains and other taxes through the 1031 exchange rules, many of these “mom and pop” independent investors would be subject to tax bills that could rob these investors of realized gains after decades of hard work. May be 40%. Build a modest real estate portfolio.

William Brown, former president of the National Association of Realtors summed it up well in a New York Times article When he said, “Getting rid of the 1031 Exchange would hinder the opportunity investors because most investors cannot afford to sell a property and then buy Anything else after paying taxes.

Force Three: Economics

Finally, there is something inherently good in Internal Revenue Code 1031. That is, exchanges of various kinds help in the promotion of commerce. through many other industries such as banking, construction, landscaping, and insurance.

A famous study Professor David C. Ling of the University of Florida and Milena Petrova of Syracuse University analyzed how 1031 exchanges encourage useful economic activity and development that also supports local commercial real estate markets and local tax bases. According to the study, the DST 1031 exchange also achieves the following three key economic benefits:

1. Similar exchanges are associated with increased capital investment and lower loan-to-value ratios (in other words, less debt) on replacement properties.
2. Tax-deferred exchanges improve the marketability of highly illiquid commercial real estate. This increased liquidity is especially important for the many non-institutional investors in relatively inexpensive assets, which comprise most of the market thanks to real estate-like exchanges.
3. 1031 exchanges increase investors’ ability to redeploy capital to other uses and/or geographies, upgrade and expand the productivity of buildings and facilities, which in turn generate income and job-creating expenditures.

conclusion

By recapturing capital and real estate in a compressed time frame, 1031 exchanges and Delaware statutory trusts aid the economic development of cities and states across the country, making such legislation a relevant and important tool for the preservation and continued strengthening of wealth. make components. economy of the United States.

Note by BiggerPockets: These are the views expressed by the author and do not necessarily represent the views of BigPockets.