Last week we got a call from a referral partner of ours in Los Angeles who said his client was in dire need of a solution for her 1031 exchange. She was down to her last 3 days of her 45 day ID period and they were scrambling because the other properties that were identified were not as advertised. Those properties fell out of escrow and she had nowhere to go to defer her capital gains on an all cash $900,000 property.
We ended up saving her 1031 exchange and along with that, hundreds of thousands of dollars in tax. The best part? She’s now in two high quality Delaware Statutory Trusts (DSTs) which are institutional grade properties and she couldn’t be happier with her investment decision.
Here’s how it all went down.
Getting the Call
In the afternoon on Thursday, June 13th, we got a call from a tax professional saying that his real estate agent had a client that needed to identify new property no later than 5p on Monday, the 17th. He indicated that we needed to get on a zoom call immediately in order to help this real estate agent and his client defer the capital gains taxes which would be astronomical, considering the size of the sale and the amount of depreciation the client took over the last 20 years.
We set a Zoom call up for 11a on Friday, June 14th and we jumped on to help the client understand what her options were as it relates to investment properties for her 1031 exchange.
It was clear that the client really liked industrial property and also wanted to invest in a multifamily asset with debt which gives her more basis for potential depreciation. Her tax professional thought this was the best way to maximize any of the cash flow that may be produced from the DSTs, so we went straight to work to figure out which deals would be best suited for her situation.
The DST Market
About 60% of the DSTs in the market today are multifamily properties, ranging in unit count, location and targeted cash flows. Some of the stronger sponsors in the space have been able to find properties in growing markets and because Fannie and Freddie offer better loan terms than commercial properties, they’re offering deals with competitive targeted cash flows and higher, more conservative debt to service coverage ratios.
In this case, we found the client a property wherein the asset is 7 years old and offered roughly 50% loan to value, thus checking the box for the accountant’s desire for leverage to maximize the client’s depreciation benefits. The 349 unit apartment complex was purchased in the low 6% cap rate range, which has the potential for driving long term value in a market that historically has shown population growth. With a business plan in place for value add, this deal was one of the multifamily offerings the client liked best.
Additionally, we looked for an asset that gave the client the ability to invest in an industrial building that was rented by a manufacturing business. Thankfully, we had a great deal that provided the client with what she was looking for – a long term, NNN lease with contractual annual rental bumps, high quality tenant and upside rental potential.
Father’s Day Call
After our call on Friday afternoon, we went into ludicrous speed putting together all the required documents to ensure the client was able to get into the deals that we discussed with her. We touched bases with our sponsor partners and requested they hold the equity for us as the client was in a really tough spot. They were happy to accommodate and within a few hours of ending our zoom call, we sent over the custom Private Placement Memorandums, offering materials, and various other pertinent information for the client to read and analyze as quickly as possible. We scheduled a followup call for Sunday to ensure we went through all questions and the client knew how the process was going to work moving forward.
Sunday morning at 11a, we jumped on another zoom call to run through all the questions that the client had for the deals we went over together. It was clear that she was excited about finalizing and selecting the two offerings which we all agreed aligned best with her investment goals.
She was ready to move forward with identifying those properties for her 1031 exchange.
The Final Countdown
Monday morning we called the QI to confirm the change of addresses on the identification worksheet, which they said they had received. Because we used addresses of two single asset DSTs, the client was able to identify a third, fee simple option in case she decided to change her mind.
Though the client had a third option, she decided to move forward with the two DSTs that we discussed, so we completed the required documents to begin the process for her to buy into those offerings.
Conclusion
For 1031 exchange investors who are down the wire on their 45 day identification period, DSTs can be a life saving strategy to strive to achieve the deferral of capital gains when selling an investment property. In this case study, we were able to assist an investor who was in a sticky situation and in 3 days, we were able to help her underwrite, analyze and ID two institutional grade assets – both of which offer potential cash flow and appreciation. We were able to check the boxes for the client’s preferred property types, desired markets and minimum cap rates and she is so happy knowing her 1031 exchange was saved.