Delaware Statutory Trust (DST) and 1031 Exchange Consultants
Carl and Carlos Sera
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How We Got Started: Read about how we saved our client over $800,000 in taxes.
A funny thing happened to us in 2015.
One of our clients called. She was a 77-year-old widow with one daughter. Our client had a real estate portfolio which she had been managing for quite some time and an investment portfolio which we managed for her at Charles Schwab and Co.
She had a number of debt-free properties that she and her late husband had accumulated over the years and she wanted to know if there was a smart way to liquidate her real estate holdings. She was tired of managing them and wanted to know if we could help.
In other words——-She simply wanted out. She no longer wanted to deal with the classic T’s of tenants, trash and toilets.
In her case, the properties she wanted to sell would net approximately $2.5 million. Here’s the bad news—-when we did the calculations with her CPA, attorney and real estate agent, she would only net about $1.7 million dollars. The remaining $800,000 would not go to her or her daughter, but to pay the four taxes associated with the sale of her real estate.
I’m sure that when people embark on their real estate acquisition journey, they don’t think about what happens when they want to get out or sell. So, I will tell you. You must pay the piper-unless of course…… and we’ll get to that later.
What happens exactly?
Upon the sale of an appreciated investment property that more than likely has had a decreasing cost basis due to depreciation, the investor will pay 1) A federal capital gains tax of as much as 20%, 2) The Net Investment Income Tax or Obamacare Tax of 3.8%, 3) A 25% Depreciation Recapture and 4) A state capital gains tax. In many cases, especially in high capital gains tax states, you could end up paying more than a third of your sales proceeds in various taxes.
To make matters worse, this isn’t the only tax you will pay. If you’ve been extremely successful in your real estate acquisitions, you will upon your death have to pay an addition federal and potentially a state estate tax.
I’m fairly certain that when my 77-year-old widow started buying commercial and residential real estate with her late husband that she had no idea she would have such an aggressive silent partner when it came time to liquidate. Fortunately, there is a solution.
Now, if you know anything about financial advisors, you know they know very little about how real estate fits into a portfolio, how real estate roll-overs or 1031 exchanges work and even less about how to orchestrate the efficient transfer of real estate as part of a legacy or estate plan.
Back in 2015, we weren’t much better, but in our pursuit to find a tax efficient solution for our client, we inadvertently began to master a very complex set of circumstances and developed a solution that we have now shared and implemented with a missionary zeal. If you pay attention, you will understand how this might work for you.
What would we have done in 2015 and what would most financial advisors do today if presented with our 77-year-old client?
The answer is cookie-cutter and straight from the financial planning manual. Our client would sell the properties, pay the taxes and re-allocate the $1.7 million to the Charles Schwab and Company investment portfolio. Once there, the advisor can charge incremental fees for managing even more money and the client can receive income.
How much income? Using the magic 4% financial planning solution, our widow would be receiving $68,000 per year which is 4% of $1.7 million. From this $68,000 she would then pay some of it in taxes and get to spend about $60,000 per year or $5,000 per month.
Let me repeat, the above example is the standard financial planning solution and once you learn about our alternative solution, you may decide that “standard” actually means—”substandard.”
What if there was a way for our widow to sell the properties and avoid paying the 4 taxes while alive as well as after she passes away?
What if there was a way to increase the amount our widow could spend from $60,000 per year to almost double that amount?
Finally, what if there was a way to make certain that her daughter would eventually receive all of the income as well as the proceeds and capital appreciation of her mother’s real estate?
Our solution did exactly that, it avoided current taxes and assuming the estate tax laws don’t change, will avoid all future taxes. It almost doubled her spendable income when compared to the standard financial planning solution and it ensured that upon our client’s death, the daughter would not have to deal with the hassle of selling the properties and instead would receive her mother’s income and soon thereafter her capital appreciation.
As soon as we recognized the potential of our solution, we did what we always do before implementing it. We dug deeper. We called every real estate professional, real estate developer, real estate accountant and real estate attorney that we knew and explained what we were doing.
They were, of course, all familiar with real estate like-kind exchanges (or real estate rollovers – as we like to call them), but not one knew about the ability to rollover from real property to an ownership structure that allowed smaller investors to own a fractional interest in large, institutional quality and professionally managed commercial property.
At this point we knew we had something different and that we would spread the word to all that would listen. We had taken a deep dive and developed an expertise that most others in our industry lacked. With every deal we do we get a little better as we can see the nuances that make a deal successful vs deals that fall apart.
Since then, we have dedicated hundreds of hours to due diligence and understanding the players in the 1031 space with the end goal of solving a problem that awaits many of our friends and clients. We knew it is superior to the standard financial planning solution and our intention is to replicate this solution as many times as possible for those that find themselves in a similar position as our first client.
Along the way we developed a business plan for the solution and partnered with various tax, legal and real estate professionals as well as qualified intermediaries in order to make the implementation as easy as possible.
So, what’s the solution?
The solution is, a 1031 exchange in conjunction with a Delaware Statutory Trusts or DSTs, and the profile of a successful implementation requires that our clients exhibit certain characteristics.
These characteristics are almost universal. The profile is someone that no longer wants to deal with owning real property. They are done with the headaches of being a landlord and want to convert their active involvement into a passive activity.
They are at a point in life where they are looking for what we call “mailbox money.” They simply want to go to the mailbox once a month and receive a check.
It’s why our tag line is,
“Sera Capital—helping landlords retire tax efficiently.”
If you don’t fit this profile, you are currently not a good candidate for our solution. But it doesn’t mean you won’t be a good candidate in the future. We’ve seen this happen a number of times,
A person we’ve educated about our solution tells us “not for me” then a few years later we hear from them and they say “could you explain that thing again, I think I might be ready.”
If you are reading this, we hope you don’t feel like we’ve pulled a bait and switch. Our style of education is to tell tales or case studies and once again, we encourage you can read our book Financial Tales to understand why we do it this way.
We wanted to set the backdrop of the ideal profile for a 1031 exchange before we got into the rules and regulations of it, since without context, we’ve learned that our clients don’t immediately grasp the power of how to use 1031 exchanges in conjunction with DSTs and most importantly, the reasons to use them.
So, without further elaboration, let’s take a shallow dive into 1031 exchanges.
1031 exchange rules, real estate like-kind exchange rules and real estate rollover rules, they’re all the same thing.
1) A 1031 exchange gets its name from, not surprisingly, Section 1031 of the IRS code and allows an investor to “defer” paying taxes on an investment property when it is sold as long as another “like-kind property” is purchased with the profits from the sale of the first property.
2) So why do real estate investors utilize 1031 exchanges? For one reason and one reason only———to defer taxes.
3) So, if the only reason to utilize a 1031 exchange is to defer taxes, then the compelling question must be—how much tax will I have to pay if I sell an investment property? For those that are curious, we have a free capital gains tax calculator that can give you an approximate answer to the question or you can contact your tax professional or use one of ours for a more precise answer.
4) If the tax savings from utilizing a 1031 exchange are sufficient to make you move forward then you must do three things in order to make it a success.
- The first is obviously, you must sell the investment property at an acceptable price.
- Next, you can’t take receipt of the funds from the sale, those funds must be temporarily placed with a qualified intermediary until you direct them to purchase the replacement property.
- Lastly, you must identify a replacement property or properties within 45 days of selling your original property.
5) As anyone that has attempted a 1031 exchange can attest, most 1031 exchanges fail because the seller can’t find a suitable replacement property. That’s where Sera Capital shines. We monitor and track the amount of available inventory eligible for a 1031 exchange and specialize in helping you find the right replacement property. Specifically, we partner with real estate professionals that focus on 1031 real property for real property exchanges and if these are not appropriate, we substitute a very special type of replacement property called a Delaware Statutory Trust or DST.
6) So, what is a Delaware Statutory Trust or DST? If you search for DSTs you will come across a number of explanations. The following are the salient points and how we view them.
- DST Investments are offered as replacement property for accredited investors seeking to defer their capital gains taxes through the use of a 1031 tax deferred exchange and as straight cash investments for those wishing to diversify their real estate holdings.
- Guess what, we have yet to recommend a DST investment to anyone other than someone that is utilizing a 1031 exchange. Why? Because DST investments are designed as conservative real estate investments. When someone purchases a DST, they are more interested on the return of their money than the return on their money. If they were interested in more aggressive real estate investments, the DST is not that vehicle.
- For higher return/higher risk vehicles, contact us.
- The DST property ownership structure allows the smaller investor to own a fractional interest in large, institutional quality and professionally managed commercial property along with other investors, not as limited partners, but as individual owners within a Trust.
- Each owner receives their percentage share of the cash flow income, tax benefits, and appreciation, if any, of the entire property. DSTs provide the investor the potential for annual appreciation and depreciation (tax shelter), and most have minimum investments as low as $100,000, allowing some investors the benefit of diversification into several properties.
- The DST ownership option essentially offers the same benefits and risks that an investor would receive as a single large-scale investment property owner, but without the management responsibility.
- Each DST property asset is managed by professional investment real estate asset managers and property managers.
- It used to be that only large institutional investors such as life insurance companies, pension funds, real estate investment trusts (REITS), college endowments and foundations were able to invest in these properties. Now as a viable 1031 exchange replacement property option through a DST, individual investors have the ability to invest in a diversified selection of institutional quality, investment property types that they otherwise could not purchase individually.
- DST Investments are located throughout the United States. Property types may include multifamily apartment communities, office buildings, industrial properties, multi-tenant retail, student housing, assisted living, self-storage facilities, medical office, single tenant retail properties and others.
It is our job at Sera Capital to monitor, review, access and advise our clients on the DSTs in the marketplace that we find attractive.
As a final point. Sera Capital works in the 1031 Exchange / Delaware Statutory Trust (DST) space as consultants and fiduciaries. We think it is important that before anyone takes the plunge, they understand how the bulk of our competition works and what sets us apart.
Why do we continuously get referrals from other professionals? The answer is our expertise, our ability to see a transaction through from beginning to end, our transparency and most importantly our no-conflict fee structure.
Unlike others that attempt our solution, few have completed as many successful exchanges as we have or are as proficient in understanding the entirety of how investments other than real estate fit into a client’s retirement plans and legacy plan. Having worked for over 30 years and still working as fee-only registered investment advisors, we are keenly aware of the role each type of security plays in someone’s overall portfolio. Furthermore, we have designed our 1031/DST fee-structure to align with our investment advisory agreement.
What do we mean by alignment? It means that upon inspection, DSTs have embedded sales charges that vary from sponsor to sponsor. A DST salesperson that simply sells DSTs as a product or security will charge the client the full embedded sales charge. We have seen sales charges as low as 6% of the investment and others can exceed 10% of the investment. This creates a tremendous misalignment of interests between the salesperson and the client. When the salesperson has a financial motive to sell the higher fee investment to their client, this is an unhealthy situation.
We solve this problem by crediting 100% of whatever the embedded sales charge is to the customer.
As an example, if a customer invests $100,000 into a DST that has a 7% embedded sales charge that would normally go to the salesperson, we credit this $7,000 to the client and instead of only owning $100,000 of the DST, they own $107,000 instead. We of course charge a fee for our services but the fee is based on a combination of our level of time commitment as well as the amount of the investment.
CPAs and Attorneys are particularly fond of our billing model since it is aligned with their clients, has no conflicts of interest and is similar to the way they bill their customers. It’s the reason so much of our business comes from CPA and Attorney referrals.
Over the years, we’ve learned that our solution is not a cookie-cutter solution but a custom solution which requires a number of meetings with our client and typically with multiple advisors until it is well understood and coordinated.
What else? If you’re reading this, maybe you’ve already heard of our competitors. We would encourage you to ask how they bill their clients. Maybe they say, “there’s no cost to clients,” or that “the sponsor pays them a small commission.” It’s important to understand that when people work with brokers, the DST sponsor pays the broker a commission and when people work with Registered Investment Advisors, the client pays the advisor a fee. Either way, the client ends up paying. When everyone has access to the same inventory, it’s clear to see why people who do their homework choose to work with a Registered Investment Advisor like Sera Capital vs a commission-based broker. After all, you wouldn’t pay full price for a jar of Skippy when you can get the same jar for less.
In closing, we’ve had the opportunity to work with people that have sold, rental homes, vacation property, land, farms, office buildings, industrial buildings, multi-family properties and hotels. We pride ourselves on our transparency, our due diligence and our fee structure and we only work with the top DST sponsors that have a proven history of success. So, if you see yourself selling in the near future and the situation is right, give us a call.
We hope you’ve enjoyed our solution.