1031 Exit Strategies
El Salvador/Florida · Member since 2016 · 10 posts · 2 votes
1031 Exit Strategies
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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes@Eddie Pfeifer, One option that might just work for you would still be to continue the 1031 and thus continue the tax deferment. But make the replacement property something that could be positioned as your primary residence when you do move back.
The 1031 requires that you sell investment property and buy investment property. But the type does not matter. And you do not have to maintain the property as investment forever. You can convert an investment property to your primary residence and not trigger the tax. There is even a two year safe harbor from the IRS.
That positioning might allow you to then take cash outside your exchange that you would have normally used for housing and use it instead for active investment. And even better, after you've owned that converted property for at least 5 years and have used it as your primary residence for at least 2 years you can then sell and actually still take a portion of the profit tax free allocated between your primary use and the investment use.
Not a bad plan to consider and see if it lines up with your movement desires.
The 1031 Investor5140 Reviews
20 Replies
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes7y
Is your property paid off or loan terms on it? The NNN property is it absolute NNN, NN, or a ground lease?
With 1031 it is NOT just long term capital gains but possible state income tax, depreciation recapture, and any medicare tax. The tax burden could be SUBSTANTIAL. Before looking at any options you need to talk to your tax accountant to determine what your tax liability would be if you did not 1031 or if you did a partial exchange and had BOOT which is taxable. You also need to be talking to your qualified QI 1031 company.
You could possibly sell the rural property and 1031 exchange into a a retail strip center that has possibly better returns. The DST as mentioned has a bunch of limitations and often the sponsors front load the fees and the properties when sold later on are generally break even at best. There is the TIC model as well. Both have certain requirements to qualify which you may or may not depending on criteria.
To see what would might make sense I would need to see info on the NNN property you currently own and the lease abstract with terms.
No legal advice given.
- Professional · San Francisco, CA · Member since 2014 · 876 posts · 301 votes7y
@Joel Owens brings up good points about considering depreciation and income tax. Best to consult with you account first. Most likely you'll have to pay some amount if you stop exchanging.
- El Salvador/Florida · Member since 2016 · 10 posts · 2 votes7y
@Joel Owens @Leslie Pappas Thank you for the replies. I am looking into any and all possible ways out of a 1031. I am aware of the tax burden and other issues such as depreciation recapture. I was hoping for guidance toward a DST-like product (if it exists!) which might allow us a way out as I'm not interested in paying my way out of a 1031 due to the financial implications.
So we would like to know our options. As I understand them, they are:
1) Keep NNN and hope they exercise 5-year options at end of lease
2) 1031 into another NNN. In this scenario, We'd be kicking a bigger (due to each upleg having to be higher in price than current property and likely higher debt each time) can down the road, as we'd still have the ticking time bomb issue with a lease expiration and the fee churn for doing this. We also have almost no control with a NNN.
3) 1031 into a more management-intensive property. This would for my peace of mind purposes mean we'd be moving back to the States so I could oversee something like a self-storage or mobile home property. This is my preferred option but am facing major static from the Mrs as she doesn't want to move again. I realize the two hypotheticals in this paragraph can be set up so as to be managed remotely through employee help/management companies but with so much of our net worth tied up in it, I would be checking in on an at least biweekly basis.
4) "Default" on 1031 and pay sizeable recapture/capital gains penalties. This isn't an option for us.
5) Something like a DST. I realize after reading Joel's comment that a DST itself isn't the answer.
I realize I am asking for something that almost certainly doesn't exist but am interested to hear all creative (and legal ) solutions. We would love to own another property but since my wife would MUCH prefer to stay here in Central America and I'm a boots-on-the-ground guy (in a non-NNN scenario)... well, you can imagine our schism.
Our NNN is a Dollar General and has 11 years left on the lease at a 7.25% cap. We have a loan on it for less than half of its value. The property is relatively worthless should DG decide not to renew lease at end of contract.
Thank you once again for taking the time to reply.
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes7y
Hi Eddie,
Unfortunately it is a common theme with Dollar Stores. Most Dollar Stores 1,500,000 and below typically are in rural to weak suburban locations and have front stucco or sheet brick facade with sheet metal sides and back.
About 15% of Dollar Stores are upgraded full brick etc. type construction in what I would consider to be good solid strong suburban locations. Due to land value and what rents have to be charged to pencil a project. Those tend to be 6.5 to 6.75 cap rates and 2 to 2.5 million in price points. Those are not 7.25 caps rate. Most stuff STNL 2 million and under to get anywhere close to 7 cap need a dollar store. Most well located other asset types are 5 to 6 caps. So you have to buy all cash or have a loan where most of the income goes to service the debt. Now if you buy STNL in 4 to 6 million range then cap rate starts moving into the 6's for some national tenants. So it's a function of location, lease term left in primary, and quality of the tenant backing the lease and if parent corp. guarantee or not. Used to Dollar Stores had rental increases in primary term but they changed that awhile back. Personally if people want STNL and will accept flat rent in primary I like pharmacy better. Hard corner location with high traffic counts in a suburban area all brick about 12,000 sq ft box size on prime land of 1.5 to 2.5 acres. That tends to hold value better than a cheaply built box in a rural type area that a second generational tenant likely will not like.
Some of my clients buy dollar stores. They are not my favorite but sometimes the client wants a certain yield and so they buy them as other properties are 5 and 6 caps. I have been lately finding for clients quality Auto Zone, Oreilly's, Advance Auto type stores in strong suburban areas doing well for cap rate and price point under 2 million. The construction tends to be a lot better quality than the Dollar Stores.
If you have Dollar Store in a rural area you might want to sell it now and 1031 into something else while you can. Once the primary lease has under 10 years left the cap rate starts to rise to sell so most hope to breakeven when they sell after expenses with the equity they have put in and the bonus is the cash flow while owning.
If the wife does not want to move you might want to leave that one alone. You do not want to be reminded everyday for the rest of your life what she told you NOT to do..lol
You might could own a retail strip center with national tenants in a strong suburban location. Those go for about 2.5 to 4 million or so in price and have rental increases and starting cap rate 6.5 to 7 cap. I do not mind going up in debt for the RIGHT location and property. I see it a lot where people think 1 million property in rural area with 500k loan is safer than buying 2 million property. Not if the property is worthless down the line when you want to exit. I would rather own the 3 million property in a high quality strong suburban location where future dirt value is strong.
From what you are describing a DST is not going to be this amazing return and headache free product. I have a 1031 exchange company you could talk to plus I have a friend with his securities license that does capital raises for DST's. He can often go over in high level detail the pluses and minuses of them. He is pretty neutral on the subject. DST companies themselves usually position all the positive and none of the negative when selling DST's because they want the buy in. DST's do work in certain situations. Some of my clients just like the control of owning their own property. Anymore detail I would need to talk on the phone as every investors situation varies.
- Professional · San Francisco, CA · Member since 2014 · 876 posts · 301 votes7y
@Eddie Pfeifer, @Joel Owens mentioned DSTs (referring to Delaware Statutory Trusts, not deferred sales trusts) being break even and I'm going to have to disagree. Reputable Sponsors provide detailed track records of their history.
DSTs are 1031 eligible and can work great for people looking to avoid tax on their sale and just want hands off real estate plus the income.
Of course there are many aspects to the due diligence, including knowledge and inspection of the properties, which is why I personally visit each multifamily and student housing DSTs (as well as several commercial properties in retail portfolios) we recommend.
Sponsor selection or offering selection is closely tied to your DST experience will be positive or negative. It's vitally important to know who you are working with, and have the history of the players involved. I see former players from the 2000's coming back to the industry under different business names, and some of their prior work was less than stellar. It's important to have the advice and perspective of an industry old-timer, in my opinion.
If there's anything I can do I'm happy to answer any questions. Here is a link to my blog on here that goes into more detail on DSTs.
- 7yDave FosterBusiness MemberQualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
@Eddie Pfeifer, One option that might just work for you would still be to continue the 1031 and thus continue the tax deferment. But make the replacement property something that could be positioned as your primary residence when you do move back.
The 1031 requires that you sell investment property and buy investment property. But the type does not matter. And you do not have to maintain the property as investment forever. You can convert an investment property to your primary residence and not trigger the tax. There is even a two year safe harbor from the IRS.
That positioning might allow you to then take cash outside your exchange that you would have normally used for housing and use it instead for active investment. And even better, after you've owned that converted property for at least 5 years and have used it as your primary residence for at least 2 years you can then sell and actually still take a portion of the profit tax free allocated between your primary use and the investment use.
Not a bad plan to consider and see if it lines up with your movement desires.
The 1031 Investor5140 Reviews - Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes7y
A DST as an investor holding for 5 to 7 years is a long time for investment without having control of the asset. If problems arise with the asset the IRS pigeon holes workout options. If an investor needs to sell their share early they likely are taking a discount. I have some companies that buy partial interests but only do it at a discount. The upfront fees to buy in to a DST are very heavy. The sponsors make the fees with volume.
The payout percentages tend to be smaller compared to more traditional syndicated deals.
Some investors do like DST's because they do not have to do much of anything. With a regular 1031 timeline of 45 days to ID many investors have a hard time with it. My 1031 clients I tell them they have to be dedicated to the process daily until closed to buy where they own directly as it goes fast. As a commercial broker there is effort involved to get to closing but mostly passive for clients thereafter. With DST you dump into it quick but also can have many negatives for being that easy to buy into.
DST's can also work when someone has say a few hundred k leftover and have already bought one 1031 property they own directly and do not want to pay boot for leftover funds. TIC's tons of those failed in the last down turn. Trying to get everyone with a voting share to agree what to do with a property can be a nightmare. TIC's tend to work better when only a few investors involved. There are some retirees who get into the regular 1031 buying process and then say it is too much effort and stress for them and they dump into a DST instead.
So DST -
1. Can be easy to buy into.
2. Not hardly any investor control and locked in for a long time.
3. Harder to exit and usually at a discount.
4. Upfront heavy fees.
5. Returns not usually as good as traditional syndicated deals.
6. If problem arises with the property workout solutions are more constrained due to DST structure.
I am not against DST's I think an investor needs to take a long hard look at them as they can work in certain situations. Finding neutral third parties to talk to can sometimes lead to a more objective opinion. Often these DTS's are (top of the market) deals at lower cap rates. If everything doesn't go perfectly over time they have nowhere to go but down in value. Multifamily for instance. If the property is 90% full and rents are way below market then maybe you can push rents up and cut costs to increase yield. The opposite can be true with multifamily. Nobody talks about the last downturn much where COSTS went up and rents FLATTENED or went down as owners tried to maintain market share from renters. Lot's of flat rent, discounted rent, free months of rent, waiving of security deposit to get renters in etc. As recession happened renters moved to more cheaper apartments trying to survive so the Class A topline and B+ assets got hit hard for occupancy and profitability.
I like retail because in a down turn with a NNN lease you have controlled costs paid by the tenant. In apartments if property taxes , utility costs paid by landlord, insurance costs, capex costs go up, and rent goes flat now yield goes way down. Right now apartments with rent growth of 4% annually is a bubble number. Over decades of time that is not the norm or sustainable pro-forma. Be careful who you invest with and the pro-forma they are giving out.
Look at the pro-forma being sold on the investment no matter what it is and question ( is this highly likely to happen, somewhat likely, or happen if everything goes perfectly or not at all). Some sponsors like to put the best spin on stuff to show the best case so they can create the buy in. When I look at investments I use worst case as my baseline and ask if it still make sense. If it does then everything above that is icing on the cake. If I need everything to go perfectly to meet my minimum criteria then a high chance of failure.
Another time a DST might make sense. I have seen potential clients in the past where they have 300k to put down but their expectation for cap rate and tenant quality at 1 million price point is not realistic for STNL. Lot's of all cash buyers in that range and so it compresses cap rates with big buyer pool. Also locations tend to be rural as well so not optimal. With a DST if investor qualifies with their 1031 exchange they could possibly invest the 300k into a much larger property in a higher quality area they could not afford on their own so in that way there is a benefit. Sometimes buyers tell me they do not want to give up control so they instead put more cash in themselves or with a family member to go up in price where they can afford a strong suburban location with a good tenant.
So for multiple reasons not every asset class will be optimal for every investor. Everyone has a different life story, goals, tolerance for investing that makes them comfortable, etc.
- 7yDave FosterBusiness MemberQualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
@Eddie Pfeifer, your concerns with debt load and that being an undesireable feature of the DST is well taken. There are ways to mitigate this without having to jump into a a debt/fee loaded DST as your only 1031 option.
1. Do a 1031 exchange but only with the cash portion of your sale. The reduction in purchase price will be taxed as boot but you could still be left with some sizable tax savings. The purchase of a debt free property - whether stand alone or a partial tenant in common situation can certainly be structured to be as passive or active as you want with the added security of the elimination of debt risk. If you have the cash reserves you can also replace the debt with cash of your own and then do a full 1031 but with all cash. There is no debt requirement for a successful 1031. Only that you must purchase at least a much as your net sale and use all proceeds if you want to defer all tax.
2. I just saw your returns on the DG. And another quirky one off solution might be an installment sale of the property to a buyer. The current cap rate is in the attractive range in general and there might be a buyer lurking with not quite deep enough pockets but a strong desire to own a local DG. Again you may need to supplement the down payment to eliminate your loan. And You'll pay the tax and recapture but it will be spread out over the years and you will have gotten rid of an asset you don't want and eliminated your need to 1031.
The 1031 Investor5140 Reviews - El Salvador/Florida · Member since 2016 · 10 posts · 2 votes7y
@Dave Foster Thank you for your insight, very helpful! Is it possible to 1031 into a business purchase if there is real estate attached? Or am I SOL on the business's value outside of the real estate?
How do you like St Petersburg? We're strongly considering a move to FL
- Specialist · Orlando, FL · Member since 2016 · 48 posts · 16 votes7y@Eddie Pfeifer - this is something we handle every day. We operate a fund, and in addition, we're a full service Commercial RE broker. We have a find you can invest in with1031 proceeds that focus on projects in opportunity zones, which offer you even more tax liability mitigation, and likely better returns, covering a few different core asset types (so you're diversified). And we also deal with NNN and Absolute NNN properties, so we could help you move into something with better returns and longer lease end dates, if that is preferred.
- Specialist · Orlando, FL · Member since 2016 · 48 posts · 16 votes7yCorrection... we have a FUND you can invest in.
- 7yDave FosterBusiness MemberQualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
@Eddie Pfeifer The changes that went into effect for 2018 now restrict 1031 exchanges to investment real estate only. So you can't exchange the FF&E of a business that goes with investment property. But you can still exchange the property. What's interesting is to get all the accountants in a room and watch them getting creative with valuation prorations of FFE vs real estate. There can be some wiggle room. You want as much value in the actual real estate as possible for 1031 purposes. But the FFE allocation gets more favorable depreciation treatment. So it's a carefully calculated dance!
St. Pete is awesome! Downtown is a lot like a mini Denver with breweries and small restaurants and event venues everywhere. You're never more than 10 minutes from the water. And when it's snowing in Denver I'm getting sand in my sandals here! The best world though is still CO in the summer and here in the Winter! Or if Aurora and Commerce City became beach front!
The 1031 Investor5140 Reviews - El Salvador/Florida · Member since 2016 · 10 posts · 2 votes7y
@Gary Perl We live abroad and we're situated with two little ones. We wanted a run-down of all of our options so as to see how feasible it was to stay here.
- Real Estate Investor · Denver, CO · Member since 2011 · 1 post · 0 votes7y
@Eddie Pfeifer, I’m in Denver, in fact just sold a property of mine on 16TH St. Mall. I’m NOT doing a 1031 with my last sell. I think you’re risking wayyy to much buying into the current state of RE. I had many talks the last months with many of Denvers RE heavy weights and the result was: Cash is going to be King in the near future. Many are selling, some are doing 1031s, but rather creative ones. Btw, one option no one mentioned here yet is to 1031 into an Opportunity Zone (and Denvers OZ are amazing). Investing into an OZ lets you write off up to 15% of your tax deferral and up to 100% of your capital gains. But it’s a lot more hands on approach. Having said this...I still wouldn’t 1031 in this market. You’re going to be f&^%d (pardon my french) if you get caught in the next downturn, and you’re not going to be able to acquire for pennies on the dollar. I have made lots of money not being greedy but patient and working the cycles. But if you really want to invest now, then I can offer you my rehab and management crew for support (Denver + 50 miles only), not sure if I’m allowed to even post this. Anyway, good luck!
- Registered Representative · Bend, OR · Member since 2018 · 91 posts · 38 votes7y
I have to politely disagree with @Joel Owens regarding DSTs. As a security (as opposed to real estate) investment option there are different suitability issues to take into consideration. For the clients that they are a good fit for, they work beautifully. There are MANY happy investors in DSTs from many reputable sponsors with long track records. These clients have returned to them when the properties roll over by completing a subsequent 1031 into another DST. To make a blanket statement that they are bad does a disservice to a different segment of real estate investing that works well for people who maybe want to preserve their investment, but not have management of their real estate portfolio be a full time job. Joel, as a moderator I'd hope you would be less subjective in your comments. An educated and experienced broker of DSTs can discuss the pros and cons with clients and more importantly will point out the good and bad points for each sponsor as well as each property offered. This last point is one of the best reasons to work with a broker as opposed to buying directly from a sponsor.
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes7y
The beauty of Bigger Pockets is investors can have varying opinions on different investment types.
In my post I mention that DST's can work in certain situations. It is just another investment option among many out there.
If someone is considering a DST they might want to try and talk to other investors that have invested in DST's for many years that are likely neutral with their opinion. With any investment there is the good, the bad, and the ugly. Investors can lose everything with any type of investment.
Investors just need to go into DST's with their eyes wide open instead of sometimes thinking they can just put money in there without very much work or discovery and everything is going to go perfectly. One good resource is a 1031 exchange company that has completed thousands of exchanges over the years. They tend to have insight into how their investor clients have fared investing in various models.
- Registered Representative · Bend, OR · Member since 2018 · 91 posts · 38 votes7y
This forum is becoming heavily opinion and not fact based unfortunately.
@Joel Owens 'Investors just need to go into DST's with their eyes wide open instead of sometimes thinking they can just put money in there without very much work or discovery and everything is going to go perfectly.'
I'm not sure who would ever present that thought process to an investor regarding DSTs or any real estate investment for that matter.
Although I've heard people on this forum buying rental properties across the country that they have never even visited so I'd say the same to those people.
DSTs are for sophisticated real estate investors that are moving on to a more advanced estate and/or portfolio investment strategy than fix and flips or buy and holds would offer. Anyone interested in a DST should purchase those investments from licensed securities brokers that have experience in that marketplace and can advise of all the important considerations and suitability issues. Securities brokers are held to a much higher standard of fiduciary responsibility than real estate agents and the properties have more due diligence materials available than most people will even take the time to read.
@Account Closed main post, and all he was doing was pointing out some basic limitations of DST's. He wasn't saying that they are inferior. His main point was that outside of selecting the sponsor, you have very little control over the investment.
And as for your last paragraph, it's a rather curious "inspirational perspective" that DST investors are somehow more sophisticated or advanced than buy and hold investors. If by sophisticated you mean achieved net worth or accrued talent in owning successful properties, I think there are varied paths to sophistication.
- Registered Representative · Bend, OR · Member since 2018 · 91 posts · 38 votes7y
Originally posted by @Amit M.:
@Account Closed I think you’re overstating your opinion here. I reread @Joel Owens main post, and all he was doing was pointing out some basic limitations of DST's. He wasn't saying that they are inferior. His main point was that outside of selecting the sponsor, you have very little control over the investment.
And as for your last paragraph, it's a rather curious "inspirational perspective" that DST investors are somehow more sophisticated or advanced than buy and hold investors. If by sophisticated you mean achieved net worth or accrued talent in owning successful properties, I think there are varied paths to sophistication.
@Amit M. unfortunately because of the securities laws set forth by the SEC and FINRA that those of us in my field must follow, we are not allowed to post about DSTs and it is always frustrating to see someone who does not have to follow those higher guidelines speak about them as if they know with opinion based comments, especially a real estate agent that likely sees them as competition for what he can sell. BP should not be a pulpit to preach and promote only what you sell and disparage everything else. This is a real estate forum and DSTs are a proven successful strategy for some investors. Like ALL investments, there are important considerations, of course. If you'd like to learn more, I need to speak with you on the phone as do all of my colleagues. I am confident that after a 5 minute call you will understand my point. I always offer referrals of other investors for potential clients to contact to learn how they have worked for them as do I am sure most, if not all, of my colleagues and I have clients on that list that have been invested in them for over 10 years. Best regards.
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