Identifying Delaware Statutory Trusts in §1031 Like-Kind Exchanges
By: David Gorenberg
There is surprisingly little information available for investors who wish to identify Delaware Statutory Trusts (DSTs) as potential replacement property in their 1031 exchange. Delaware Statutory Trusts have become increasingly popular with 1031 exchange investors, in part, because they allow diversification of a real estate investment portfolio. They also eliminate many of the headaches involved in traditional real estate ownership.
Much has been written about the basics of Section 1031 Like-Kind Exchanges. Indeed, we have published articles on the Steps to Successful Exchanges, nuances on the meaning of “Like-Kind” in an Exchange, Like-kind Exchange Deadlines, and Identification and Receipt Issues in 1031 exchanges. We have also explored replacement property investment options such as Tenant in Common property ownership and Delaware Statutory Trust properties. Yet, there is surprisingly little information available for investors who wish to identify Delaware Statutory Trusts (DSTs) as potential replacement property in their 1031 exchange.
Delaware Statutory Trusts in General
Delaware Statutory Trusts have become increasingly popular with 1031 exchange investors, in part, because they allow diversification of a real estate investment portfolio. They also eliminate many of the headaches involved in traditional real estate ownership – the so-called “Three Ts” of tenants, toilets, and trash.
Some DST investments are single-property, single-tenant properties, while others may be multi-property portfolios, and everything in between. The DST investor receives a deeded fractional ownership interest in the real estate, and the investments generally provide distributions to the investors on a quarterly basis, based upon the return provided for in the offering prospectus. DSTs may vary in minimum investment size, and in rates of return, and generally involve an asset holding period of 5-9 years, depending on the asset, the sponsor, and a variety of other factors.
Identification Rules in General
Section 1031 provides that the taxpayer must identify replacement property “on or before the day which is 45 days after the date on which the taxpayer transfers the property relinquished in the exchange.” The 1031 exchange Regulations further explain that “replacement property is identified only if it is designated as replacement property in a written document, signed by that taxpayer” and delivered, before the end of the identification period, to either the seller of the replacement property or “any other person involved in the exchange other than the taxpayer or a disqualified person". For practical purposes, even if identifying to another person involved in the exchange, the identification must be delivered to the Qualified Intermediary.
The Regulations also provide three alternative identification rules:
- The 3-property rule – Identify up to “three properties without regard to the fair market values of the properties”
- The 200% rule – identify any number of properties as long as their aggregate fair market value as of the end of the identification period does not exceed 200 percent of the aggregate fair market value of all the relinquished properties as of the date the relinquished properties were transferred by the taxpayer
- The 95% rule – if the taxpayer has identified more than three properties, and their combined fair market values exceed 200% of the relinquished property value, then any replacement property identified before the end of the identification period and received before the end of the exchange period qualifies, “but only if the taxpayer receives before the end of the exchange period identified replacement property the fair market value of which is at least 95 percent of the aggregate fair market value of all identified replacement properties.” [Reg. §1.1031(k)-1(c)(4)(ii)(B)]
Finally, the Regulations state that “Replacement property is identified only if it is unambiguously described in the written document or agreement. Real property generally is unambiguously described if it is described by a legal description, street address, or distinguishable name (e.g., the Mayfair Apartment Building).”
Identifying Delaware Statutory Trusts
Applying the identification rules to DSTs has proven to be vexing for many taxpayers, and even some of their advisors. For example, identifying “Dallas Office DST #1” with nothing more, is rarely accurate, since the taxpayer is likely not acquiring the entire DST alone. To be accurate, the taxpayer must identify their target property unambiguously and with specificity. This taxpayer could identify “a $200,000 interest in Dallas Texas Office DST #1”. When identifying based on a dollar amount, they should indicate the total value of their investment, including debt, and not just the amount of exchange cash being invested. Similarly, they could identify “a 1.2345% interest in Dallas Office DST #1”. Some advisors might even suggest taking this a step further and including each of the underlying properties in the DST – “a 1.2345% interest in Dallas Office DST #1, including a 1.2345% interest in 800 Main Street, Dallas, Texas, a 1.2345% interest in 600 Commerce Street, Dallas, Texas, a 1.2345% interest in 500 Elm Street, Dallas, Texas, and a 1.2345% interest in 901 Main Street, Dallas, Texas.”
While there does not appear to be any requirement that the taxpayer list each individual property as part of their identification, each property within the portfolio does count toward the identification rules discussed above. In the case of our Dallas Texas Office DST #1, our taxpayer must recognize that there are four properties within the DST, and thus is beyond the definition of the 3-property rule. However, if the DST includes a single CVS, an identification of “CVS-DST 1411 Main Street, Dallas, Texas” would certainly be considered one property.
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