What is a 1031 Exchange?

The 1031 Exchange is an IRS-approved transaction that allows a person selling real estate to defer the capital gains tax on the sale amount of investment properties, as long as the seller then reinvests the proceeds into one or more similar properties within 180 days. 1031 Exchanges in Colorado can be a great tool for anyone looking to defer capital gains and purchase a replacement property. 

It is not a requirement for the new property or properties being purchased to have a higher price tag. However, if the new property does not end up costing all or more of your capital gains, you will have to pay capital gains tax on the amount that is not re-invested. For example, if you have $500,000 worth of capital gains and buy a property for $400,000, you will still be required to pay capital gains tax on the $100,000 left over.

What is a DST 1031 Exchange?

A DST 1031 Exchange is similar to a standard 1031 Exchange in that it defers capital gains tax however, instead of reinvesting the profits directly into another property, with a DST 1031 Exchange, you invest the money into a trust. Other investors also contribute to the trust which is generally used to purchase multiple properties that are then managed by individuals or management groups, not the individual investor making the exchange. This means you will not be responsible for day-to-day tasks like managing tenants and dealing with maintenance requests. Depending on how much you invest with the DST 1031 Exchange option, you will get a certain percentage of the profits made from the properties in the trust.

In short, a DST 1031 Exchange allows investors to re-invest and benefit from property investment gains without being solely responsible for managing the underlying assets. 

Why would you want to use a DST 1031 Exchange?

Besides the obvious of being able to defer your capital gains tax, there are plenty of reasons to consider using a DST 1031 Exchange. 

  1. With a DST 1031 Exchange in Colorado, you can invest in a larger, more diversified, portfolio of properties than you may not have been able to invest in as an individual. 
  2. 1031 exchanges are required to be completed in 180 days. If you can’t identify a property and close in time, you will be forced to pay capital gains tax. Investors in a DST can decide whether they want whole-property or fractionally-owned purchases. Exchanging into fractionally-owned shares in a DST is generally a much faster option for re-investment.
  3. A DST 1031 Exchange relieves you of day-to-day property management duties.

How does investing in a DST 1031 Exchange work? 

The steps for a DST 1031 Exchange can be confusing but our wealth managers can offer helpful guidance. See how it works below:

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DST 1031 Exchange
  1. A person selling a property agrees to allow a qualified intermediary to facilitate the exchange.
  2. The seller then relinquishes their property to a buyer.
  3. The profits made from the sale are then transferred to the qualified intermediary.
  4. The qualified intermediary then uses the gains to buy a replacement property or into the DST on the seller’s behalf within the time limits defined by the IRS.
  5. The investor closes within 180 days and owns a replacement property, or a fraction of a property or properties held in a DST.

Benefits of DST 1031 exchanges

  • Property-level debt does not affect the individual investor’s personal credit.
  • You can purchase a larger, potentially more profitable property, that you may not have been able to afford on your own. 
  • DSTs have a much smaller minimum investment versus buying a property outright on your own.
  • A DST 1031 Exchange can own multiple locations to diversify your real estate portfolio.
  • Multiple, flexible ways of exiting the trust.

Risks of DST 1031 exchanges

  • The investors do not have as much control over the decisions made about the properties they own.
  • If the trustee violates any of the mandatory tax restrictions, each individual investor’s investment could be immediately taxable.
  • DSTs are more illiquid since you would be part of a trust. Since the property/properties are owned my multiple investors, it is also not as easy to for an heir to obtain your investment.
  • The tax code could change, which could negatively impact the tax deferment.

In our opinion, a wealth advisor with real estate experience like Morgan Rosel Wealth Management should be consulted before making real estate investing decisions. Real estate investment decisions directly impact your financial plan and overall wealth management strategy. We have extensive experience advising clients on 1031 Exchanges in Colorado and have diligently sought to provide invaluable real estate investing advice to many of our wealth management clients. Contact a Morgan Rosel Wealth Management advisor with experience in real estate to discuss whether a 1031 Exchange or DST 1031 Exchange is right for your situation. 


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