Article

The investor’s guide to a 1031 exchange via a DST

Tips on how to execute a 1031 exchange

June 27, 2023 · Authored by Tracey Nguyen

A Delaware Statutory Trust (DST) is a trust formed under the Delaware statutory trust law that allows passive, fractional ownership in real estate while qualifying as a “like-kind” real estate replacement property under Section 1031.

Section 1031 of the Internal Revenue Code allows taxpayers to defer paying tax on the gain from the sale of business or investment real estate by reinvesting the gross sales proceeds into similar real estate property(ies) with a fair market value equal to or greater than the fair market value of the sold property(ies) as part of a qualifying like-kind exchange.

How do I execute a Section 1031 exchange?

In addition to searching for replacement properties and DSTs ahead of closing on the sale of your real estate, advance planning is important because the majority of 1031 exchanges are not executed with the simultaneous sale and purchase of replacement property. To accomplish a deferred exchange, engaging a Qualified Intermediary (QI) before closing on your sale is required to ensure compliance. The role of a QI is to defer constructive receipt of sale proceeds until the replacement property is ready to close. From a tax perspective, the QI receives and transfers the sold property and subsequently acquires the replacement property and transfers it to you to complete the exchange, as shown in the diagram below.

What is boot?

Boot is the term used to describe a portion of the exchange transaction that is not “like-kind.” Boot does not invalidate the 1031 deferral, but it is taxable. Examples of boot include:

• The fair market value of personal property acquired as part of the purchase price of the replacement property (e.g., furniture or equipment).
• Purchasing replacement property less than the value of the property sold and receiving cash or debt relief.
• Reinvesting less than all of the net equity from the sale of the relinquished property and receiving cash back.

Boot is not uncommon, but the following steps will help minimize taxable boot:

• Purchase “like-kind” replacement property in an amount equal to or greater than the sold property.