Help me decide between a 1031 DST vs. a syndication.

[Matt W.]

Hi BP, 

I'm considering selling off my small portfolio of 3 SFH's and moving the money into either a Delaware Statutory Trust via a 1031 or just selling and paying the tax and then reinvesting the money in a syndication. I probably have an average of $150k of equity in each house. I live in NC, I'm 41, my wife is a high W2 earner, and we don't plan on touching this money for 12-15 years. Selling because I'm a little burnt out as a landlord and I see that my return on equity is pretty low. Yes, I know that in 10 years the houses will be worth more and will cashflow more, but that can apply to almost any investment, especially since the FED only knows how to print money.

I should note that I did a 1031 INTO 2 of the 3 houses, and did a cost segregation study and took accelerated depreciation on all 3 to offset 2022 taxes because I had a very profitable flip that year and I am a real estate professional per the IRS. I know all this deferred tax must be repaid if I were to sell without a 1031, so that tips the scales in favor of the DST option.

So the pros and cons of each option as I understand it:

1031 DST: Pro: start the investment with a bigger chunk of money because I didn't have to pay taxes on it. Not guaranteed, but very safe and boring national level companies that will not go out of business anytime soon. Con: lower returns (@7%) and higher fees. I'm not sure if my income is offset by depreciaton?

Syndication: Pro: higher (projected) returns, most seem to be around 15-20%. Cons: take a big tax hit up front, so I start with less money invested. Possibly riskier because the businesses are less established (of course I must do my proper due diligence.)

With my long time horizon before I plan to use the money, it's possible that the higher rate of return for syndications would offset the initial higher tax hit. I think both options can be rolled over with a 1031 indefinitely. I'm not smart enough to work out the math of which option would be best, or how long it would take for the syndication option to overtake the DST option.

Anyone who can help me think this thru, please chime in. Thanks!
 

[Conner Jackson]

@Matt W. Good question and we get this one a lot. There are a lot of factors and a few different ways to go about this. As you mentioned, you can go the DST route, and options may depend on the amount of debt you have on these properties. Another could be exchanging into DSTs that will convert with a 721 UPREIT, allowing you to have some liquidity in ~3 years to go into syndications. Or you can pay the taxes now and invest the remaining proceeds into syndications that potentially offer higher returns than DSTs.

I'd be happy to get you more information and look at the comparisons between the different options. I'll PM you for more details.
 

[Brandon Bruckman]

Good post!  We did build a calculator for this.  The math is one part of the equation.  The other is your due diligence on the deal and sponsor / syndicator.  I'd argue that's more important than the math as the projections are just that projections.  

On DST, yes there usually is deprecation on deals. Your deprecation schedule follows from your prior properties.

You may want to look at syndicators that take 1031 money.  Might be best of both worlds. 

[Dave Foster]

@Matt W., DSTs will give you the ongoing depreciation schedule you 1031 into with. In addition one of their more attractive aspects is that most of them already have institutional debt on them which you assume your share of. But you are not liable personally for. And this debt allows you to actually purchase additional depreciable basis. Which increases your IRR dramatically to offset the modest cash returns.

And since you get to continue deferring the tax you can 1031 again when the DST is sold to buy another one - or go back into bricks and mortar if you want the market is attractive.

[David M.]

@Matt W.

I think the benefits for the 1031 is obvious, especially since you are carrying a bunch of deferred tax liability.

Its fine to change your investment tack.  Potentially, just keep researching other investment options.

I would just like to point out that if you do NOT 1031, you have access to "all" your cash.  You only have to pay the tax "once."  If you have to borrow against your assets, you'll be continually paying for it via interest (of course, the associated argument is you'll be renting or something so the asset has to keep working for you).

Syndications have their risk.  There is another on going thread about how many of them have stopped their distributions as they are running into cashflow troubles.

So, keep researching and learning!  Good luck.

[Chris Seveney]

Quote from @Matt W.:

Hi BP, 

I'm considering selling off my small portfolio of 3 SFH's and moving the money into either a Delaware Statutory Trust via a 1031 or just selling and paying the tax and then reinvesting the money in a syndication. I probably have an average of $150k of equity in each house. I live in NC, I'm 41, my wife is a high W2 earner, and we don't plan on touching this money for 12-15 years. Selling because I'm a little burnt out as a landlord and I see that my return on equity is pretty low. Yes, I know that in 10 years the houses will be worth more and will cashflow more, but that can apply to almost any investment, especially since the FED only knows how to print money.

I should note that I did a 1031 INTO 2 of the 3 houses, and did a cost segregation study and took accelerated depreciation on all 3 to offset 2022 taxes because I had a very profitable flip that year and I am a real estate professional per the IRS. I know all this deferred tax must be repaid if I were to sell without a 1031, so that tips the scales in favor of the DST option.

So the pros and cons of each option as I understand it:

1031 DST: Pro: start the investment with a bigger chunk of money because I didn't have to pay taxes on it. Not guaranteed, but very safe and boring national level companies that will not go out of business anytime soon. Con: lower returns (@7%) and higher fees. I'm not sure if my income is offset by depreciaton?

Syndication: Pro: higher (projected) returns, most seem to be around 15-20%. Cons: take a big tax hit up front, so I start with less money invested. Possibly riskier because the businesses are less established (of course I must do my proper due diligence.)

With my long time horizon before I plan to use the money, it's possible that the higher rate of return for syndications would offset the initial higher tax hit. I think both options can be rolled over with a 1031 indefinitely. I'm not smart enough to work out the math of which option would be best, or how long it would take for the syndication option to overtake the DST option.

Anyone who can help me think this thru, please chime in. Thanks!
 

you left out the biggest factor which is risk. While some syndications can return 15-20% I have also seen several in the past week turn a $50k investment into under $1,000 which equated to a 98% loss on capital. That will take a little bit of time to get back. So I would also factor in what is your risk profile as a DST, other funds vs. a syndication all have very different risk profiles.

[Jon Taylor]

@Matt W.I have a 1031 vs no 1031 calculator model that I built that shows me the IRR breakeven to help determine the difference in risk to achieve the same quantifiable return. It's not uncommon to see a 5% IRR using a 1031 produce the exact same income and capital as a 15-20% IRR outside of the 1031, depending on your tax situation. I'd encourage you to do that work for your own scenario as a step 1.

DM me if you want help modeling that out for your own tax situation.

[John McKee]

What a great question! 

@Jon Taylor

I'm interested in that calculator!

[Carlos Ptriawan]

Quote from @Matt W.:

Hi BP, 

I'm considering selling off my small portfolio of 3 SFH's and moving the money into either a Delaware Statutory Trust via a 1031 or just selling and paying the tax and then reinvesting the money in a syndication. I probably have an average of $150k of equity in each house. I live in NC, I'm 41, my wife is a high W2 earner, and we don't plan on touching this money for 12-15 years. Selling because I'm a little burnt out as a landlord and I see that my return on equity is pretty low. Yes, I know that in 10 years the houses will be worth more and will cashflow more, but that can apply to almost any investment, especially since the FED only knows how to print money.

I should note that I did a 1031 INTO 2 of the 3 houses, and did a cost segregation study and took accelerated depreciation on all 3 to offset 2022 taxes because I had a very profitable flip that year and I am a real estate professional per the IRS. I know all this deferred tax must be repaid if I were to sell without a 1031, so that tips the scales in favor of the DST option.

So the pros and cons of each option as I understand it:

1031 DST: Pro: start the investment with a bigger chunk of money because I didn't have to pay taxes on it. Not guaranteed, but very safe and boring national level companies that will not go out of business anytime soon. Con: lower returns (@7%) and higher fees. I'm not sure if my income is offset by depreciaton?

Syndication: Pro: higher (projected) returns, most seem to be around 15-20%. Cons: take a big tax hit up front, so I start with less money invested. Possibly riskier because the businesses are less established (of course I must do my proper due diligence.)

With my long time horizon before I plan to use the money, it's possible that the higher rate of return for syndications would offset the initial higher tax hit. I think both options can be rolled over with a 1031 indefinitely. I'm not smart enough to work out the math of which option would be best, or how long it would take for the syndication option to overtake the DST option.

Anyone who can help me think this thru, please chime in. Thanks!
 

I am favouring DST because their financing model is long term fixed debt with REIT quality operator, however don't expect 10-15% in the future LOL

You would be crazy to re-invest at syndication in 2024 ; but DST is safe enough for me due to the financing aspect.

[Carlos Ptriawan]

If you are into DST, find investment somewhere in Northeast side with 10 year financing. Or find warehouse/industrial asset class DST. I see them as the least riskiest project. Typical DST is less than 50%LTV and theyare more into 'capital preservation' rather than 'cowboy operation' like in some syndications.

[Victoria S.]

Great posting! I think the comment by @Chris Seveney is the biggest and most important. Additionaly I think about, knowing my own risk profile is certainly essential, but very difficult to determine aspects of the third parties syndicator/dst risk profile, since part of what is built into those type of investments is the capacity for operators to change course in one way or another (yes, with some exceptions in the docs). Like a marriage, you certainly want the capacity to change / adjust, but that can lead to a breakup, or a complete change of heart. The child (property) stuck in between.

[Carlos Ptriawan]

Quote from @Victoria S.:

Great posting! I think the comment by @Chris Seveney is the biggest and most important. Additionaly I think about, knowing my own risk profile is certainly essential, but very difficult to determine aspects of the third parties syndicator/dst risk profile, since part of what is built into those type of investments is the capacity for operators to change course in one way or another (yes, with some exceptions in the docs). Like a marriage, you certainly want the capacity to change / adjust, but that can lead to a breakup, or a complete change of heart. The child (property) stuck in between.

When people is asking to compare syndication vs DST it means it's totally newbie question too sorry too say.

I would say the DST is more structured like an REIT, it's the Mercedez Benz of Commercial Real Estate.

In syndication it's more like Fast-and-Furious drifting car haha, some of the operators really wild wild west, they are running with DSCR 0.6x to succumb investor's money. DST in other way around is created for capital preservation. And I am not giving sales pitches here as I receive no commision. So no, inner detail of DST is way different than syndication although mishap can still happen.

[David M.]

@Carlos Ptriawan

I guess I prefer neither of them.  Why invest in a private fund with what i understand is limited knowledge and limited oversight?  I can do the same thing with the public markets which has more oversight and at least I can see more mandatory reporting.  There are plenty of real estate and non-real estate opportunties.  Also, I'm fully liquid.  I can get out whenever I want, and if i need a "pot of cash," I'll have it.  Heard too many times of people being wealth but cash poor because they can't access/monetize their assets. 

[Chris Seveney]

@David M.

The better managed funds will have audited financial statements and typically also submit semi annual or quarterly reports.

Those that go regulation a+ also have to submit to the sec so their information is all public.

Like anything, some private are better than public and vice versa, really comes down to the sponsor/CEO and the team in the majority of instances.

[Carlos Ptriawan]

Quote from @Chris Seveney:

@David M.

The better managed funds will have audited financial statements and typically also submit semi annual or quarterly reports.

Those that go regulation a+ also have to submit to the sec so their information is all public.

Like anything, some private are better than public and vice versa, really comes down to the sponsor/CEO and the team in the majority of instances.

yes for DST they have to report and the report is extremely detailed. For DST it passed my risk profile check mark.

[David M.]

@Chris Seveney @Carlos Ptriawan

Oh okay.  Good to know.

[Wilson Pereira]

I've been following this thread as I have a similar decision I'm faced with regarding a 1031 exchange on an investment property I decided to sell. 

A bit undecided on whether to take the proceeds of the sale, pay capital gains taxes on it and invest the balance or do a 1031 exchange and replace the property with another. 

I tried to evaluate pros and cons of both options. With a 1031 exchange I get to defer any capital gains taxes but the downside is the investment is locked into another real estate property assuming I can find something suitable within the 1031 exchange timelines. There is also the opportunity cost that I miss out on by keeping capital locked up in another property. If I just sell with no 1031, I have the funds to invest right away in alternative asset classes but  have to set some aside for settling capital gains tax and depreciation recapture when filing taxes next year.

Are there any other options that I may have overlooked that make more sense from a financial and tax planning standpoint? It sounds like DST may be risky and best avoided.

[David M.]

@Wilson Pereira Not sure your situation, but take a look at my post.  real life example of not paying tax out of spite, at least in my opinion:  https://www.biggerpockets.com/forums/48/topics/1169308-equit...

You seem to have the pros/cons worked out.  One perhaps silly/stupid idea is if you invest in alternative assets, can you "make back" some funds to pay the tax --- yes, making more money, which is taxable, to cover your tax is a death spiral.  But, it would help your cash flow since other than est tax payments, your return isn't due 'till next year.

If you really want ot keep the funds in real estate, you should be able to "park" the funds into a DST via a 1031. I don't do DST's, but my understanding is they have deals where the funds can be held temporarily. Good for if you are waiting for a good/better deal, or perhaps if you are trying to consolidate funds from a bunch of smaller properties so you can do a larger deal, etc.

Not to say 1031 isn't good, but just have a healthly attitude towards paying tax, its what you do if you are making money.  Otherwise, you know the old saying about "death and taxes."  Also, I haven't found a way to pay my bills or make a major purchase by holding Title to real property...

Good luck.

[Carlos Ptriawan]

Quote from @Wilson Pereira:

I've been following this thread as I have a similar decision I'm faced with regarding a 1031 exchange on an investment property I decided to sell. 

A bit undecided on whether to take the proceeds of the sale, pay capital gains taxes on it and invest the balance or do a 1031 exchange and replace the property with another. 

I tried to evaluate pros and cons of both options. With a 1031 exchange I get to defer any capital gains taxes but the downside is the investment is locked into another real estate property assuming I can find something suitable within the 1031 exchange timelines. There is also the opportunity cost that I miss out on by keeping capital locked up in another property. If I just sell with no 1031, I have the funds to invest right away in alternative asset classes but  have to set some aside for settling capital gains tax and depreciation recapture when filing taxes next year.

Are there any other options that I may have overlooked that make more sense from a financial and tax planning standpoint? It sounds like DST may be risky and best avoided.

 this is my thought process :

if you dont have replacement property --> DST is good
if capital gain is less than 100k --> just pay tax
best USE for 1031 in my opinion-->STR in hawaii/tahoe/ski resort/FL beach
if you want to sell in phases (as REIT stock) ---> Sec 721 is good
rarely the best option is going to TIC/syndication, this would go to another rabbit hole of headache.

[Carlos Ptriawan]

the good thing about RE is .... it's easiest way to print money.
but when you print it, you have to pay tax.
if you want to defer it, then you go to another rabbit hole.
you could also do something like this.

lets say yourcapital gain is 1 Mil
your primary is 1Mil with equity 500k.

1031 your rental to another location where you wanna live
Sell your primary tax free first 500k
then move to that rental home for forever after rented for two years.

Lot of options!

[Jack Martin]

@Matt W. You could pursue a syndication with bonus depreciation to offset the gains. As long as the gain you incur from the sale of your property AND the investment with bonus depreciation occur in the same calendar year, it's possible to defer all of the tax exposure you would otherwise have.  

If you pursue the bonus depreciation strategy, keep in mind some property types will garner more benefit than others. Bonus depreciation is derived from the portion of the property's value with a shorter useful life than the buildings themselves. Therefore the property types that are the most favorable to generate bonus depreciation will be those with a high degree of what the tax code refers to as "land improvements". Examples are mobile home parks, RV parks, and golf courses where the value of the property is not primarily derived from building(s) but rather from the improvements to the land. In a mobile home park, most of the value is in the underground infrastructure, roads, landscaping, amenities, pools, fencing, pads, utility pedestals, etc, while only a small portion of the value comes from a building, like a clubhouse or laundry facility. In a similar fashion, if you can imagine how much landscaping and underground infrastructure is in a golf course as compared to the clubhouse, that will give an indication of why an extremely high percentage of the property's value is allocated to the land improvements. Properly executed, an investment in these types of property can garner substantial passive losses, often equal to the amount of capital invested (or more) even in years where the benefit begins to sunset.

A few words of caution:

- Be careful not to let the "tax tail" wag the dog. Avoid investing in a poor property or poor location, simply for the depreciation benefit.

- If you are investing passively in a syndication with bonus depreciation, make sure to vet the sponsor and understand the investment vehicle before you invest. Bonus depreciation is an incredible tax benefit, but when you take the time to combine it with the right property and sponsor, that will prove to be a wining formula.

Disclaimer: I am not a tax advisor or CPA. This perspective is solely from years of experience managing mobile home park funds and working with the tax experts around us.

All the best,

Jack

[Wilson Pereira]

Any thoughts on completing a 1031 exchange and then taking a home equity or HELOC on the property to access equity in the new property? With rates being as high as they are currently, I'm trying to determine if I come out ahead just selling my existing investment property with no 1031 or doing a 1031 followed by a HELOC or home equity instead of locking my capital up in the 1031. The other concern is a potential market correction which if it does occur will result in me being upside down on my equity position after the 1031.

[David M.]

@Wilson Pereira

https://www.biggerpockets.com/forums/48/topics/1169308-equit... if its anything like this one (this link goes to my post), better to sell...  It really depends on your numbers.  I find many people are just unwilling or unable to pay the tax, even though it can make financial sense. 

Happy to chat.  Good luck.

[Dave Foster]

@Wilson Pereira, It's all about the numbers and the opportunity cost.

If you sell and pay the tax you lose not only the tax but any compounding effect on that tax.  I paid tax on a sale once in my life - 30 years ago.  If had kept that $30K compounding at 10% for 30 years can you imagine how much more money I would have now = just from that one transaction!!!

The other side of it is that paying 5 or 7% for a heloc to invest in something that is making you 8 - 10% is a pretty good trade - especially if the other option is taking a 20% hit and then investing the rest.  losing the compounding on tax and only making 3% - 5% greater return (the arbitrage of your heloc and investment) will set you back for a long time to come.

[Wilson Pereira]

@Dave Foster, Totally agree with your statement that it's all about the numbers. In your example if you had kept the $30k compounding at 10%, that would be one large number for sure. But then again, if you had paid the $30k in taxes and ended up with a net of say $100k from the sale, and kept that compounding at the same 10% rate, you'd end up with a much larger number. HELOC rates are high now and I expect they'd be at par or perhaps higher than what I'd get if I were to invest the equity accessed through the HELOC. 5-7 years ago this would have been an easy decision. Now with the borrowing rates being where they are, I'm not sure if that's a good financial move.

[Dave Foster]

@Wilson Pereira,  And that is exactly what I did.  If I had done a 1031 on that property I would have been able to compound both the tax and the remaining profit.  And that's why I've used them for myself all this time since as well.

Refinances through helocs or conventional are strategic tools to use when you have a good performing property that you don't want to sell but has equity trapped in it.  This lets you leverage into another property and again keep the compounding going.  You're absolutely right.  If the rates don't support you don't borrow to buy.  Look at what Buffet and Apple are holding in cash right now waiting for good acquisition targets.  Same thing here but with real estate instead of companies.

It's not talked about nearly enough by real estate investors, because it requires analysis way beyond the "buy low and sell high" that everyone initially thinks about. The Internal Rate of Return is my holy grail of analysis.  Because it accounts for every way I make money on my real estate.  Appreciation, depreciation, amortization of the loan, and cash flow (and laundry machine or soda machine or parking money if applicable :) all blended to create my actual return on ownership of the asset.