Calculate Tax Liability For Selling Your Investment Property

Even in a thriving seller's market, one aspect that concerns investment property owners is the burden of capital gains taxes. For instance, in California, owners of investment properties can face tax rates as high as 42.1% upon the sale of their property. Due to the substantial tax liability in various states, many investors are now exploring tax-deferral strategies. In this case, the property owner should consider utilizing a 1031 Exchange in California.

Comprehending Tax Liability

Tax Liability = Capital Gains Tax + Depreciation Recapture Tax

As an experienced 1031 Exchange professional, one of our primary tasks when assisting a client is to help them grasp their tax liability. Tax liability stemming from the sale of investment real estate encompasses more than just the federal capital gains tax.

It represents the total sum of taxes owed when an investment property is sold. Apart from Federal Capital Gains Tax (ranging from 15% to 20%), the property owner may also be subject to State Capital Gains Tax (ranging from 0% to 13.3%), Depreciation Recapture Tax (25%), and Net Investment Income Tax (3.8%).

Five Steps to Calculate Your Tax Liability

Young woman using calculator to manage business expenses highlighting the importance of a 1031 exchange in calculating tax liability

When estimating your tax liability after selling an asset, federal and state tax authorities consider the taxable gain rather than the gross proceeds from the property sale. To determine the total tax liability, follow these five steps:

Step 1: Estimate the Net Sales Proceeds

Begin by establishing the fair market value of the investment property or the listing price if you put the property on the market. There are various methods to calculate the sales price, but the two most common approaches are the income method and the comparable sales method.

For the income method, divide the current or projected net operating income (NOI) by the desired capitalization rate (cap rate).

For the comparable sales method, investors assess the value based on recent sales of comparable properties in the local area, considering factors such as size and quality.

Smaller properties and single-family rentals usually rely on the comparable sales method, while larger properties use the net operating income to determine value. Many investors seek the assistance of an experienced broker to establish a justifiable sales price.

Step 2: Estimate the Tax Basis

Tax basis, or remaining basis, represents the total capital invested and capitalized in the asset, which includes the purchase price, closing costs, and capitalized improvements, minus the accumulated depreciation. To calculate the tax basis, consider the following example:

Assuming you purchased the property for $850,000 and invested $200,000 in capital improvements. Additionally, you have claimed $750,000 in depreciation over the ownership period. In this case, your remaining basis would be $300,000. Note that there are certain limitations regarding which items can be included in the tax basis.

For instance, mortgage insurance premiums and routine maintenance costs are typically excluded. It is advisable to consult with a tax advisor to determine the current remaining basis of your property, taking into account adjustments for capital improvements and tax deductions.

Increasing the Tax Basis:

Property owners have the opportunity to increase their tax basis by making investments in the property through capitalized improvements. These improvements, such as a new kitchen, roof, or an addition, along with financing expenses, contribute to increasing the investment in the property. When selling the property, these capitalized improvements are subtracted from the net sales proceeds to determine the property's gain.

While certain costs like legal fees, management expenses, and small repairs are treated as operating expenses and not capitalized, expenses for capitalized improvements provide owners with flexibility to increase the tax basis of the asset, rather than deducting them as operating expenses in the current year. The costs of capital improvements can vary widely, offering owners the ability to adjust the tax basis accordingly.

Decreasing the Tax Basis:

Owners of investment real estate that includes a building or structure need to decrease the property's tax basis, which affects the calculation of the second form of gain known as "depreciation recapture." The primary method to decrease the tax basis is through an annual depreciation deduction. This deduction is subtracted from the tax basis each year and is treated as a tax expense that offsets income. However, it is important to note that depreciation is eventually recaptured at the time of sale.

Despite the initial decrease in tax basis and the subsequent increase in tax costs, the depreciation deduction reduces the investor's annual taxable income and lowers the income tax due during the ownership years. It's worth mentioning that annual depreciation is mandatory, and depreciation recapture is charged based on the total amount of available depreciation throughout the ownership period, regardless of whether depreciation expenses were recorded. Additionally, easements, certain insurance reimbursements, and other tax deductions like personal property deductions can also contribute to decreasing the tax basis.

Step 3: Calculate Taxable Gain

The taxable gain represents the realized return or profit from the sale of an asset. It is derived by subtracting the original tax basis (pre-depreciation) from the net sales proceeds. Tax authorities such as the IRS and Franchise Tax Board utilize the taxable gain figure to determine the capital gains tax. To calculate the taxable gain, subtract the original tax basis from the net sale proceeds.

Continuing with the previous example, assuming your original tax basis is $1,050,000 and the net proceeds from the property sale amount to $3,250,000, the taxable gain would be $2,200,000. The second part of the tax liability is calculated based on the amount of accumulated depreciation taken throughout the ownership period, referred to as accumulated depreciation. In the given scenario, this amount is $750,000.

Step 4: Determine Your Filing Status

Your capital gains tax rate is determined by factors such as your income, tax filing status, the state where you pay income taxes, and the location of the property being sold. Various tax authorities, including the IRS, state governments, and some local governments, impose capital gains taxes on investment property sales, thereby impacting the overall tax rate and increasing your tax obligation.

At the federal level, the capital gains tax rate is as follows: 0% for investors with an annual income (including gains from asset sales) below $40,000; 15% for investors with an annual income ranging from $40,001 to $441,450; and 20% for investors with an annual income exceeding $441,451.

Additionally, most state tax authorities also levy a capital gains tax, with rates ranging from 0% to 13.3%. California stands at the top with a 13.3% capital gains tax rate, while states such as Texas, Washington, and Florida do not impose state capital gains taxes.

Step 5: Calculate the Capital Gains Tax

Hand using a calculator with passbook and house model illustrating how a 1031 exchange can help defer tax liability

The capital gains tax is calculated based on the taxable gain, considering the tax rates determined by your income and filing status. There are four main categories of property tax: federal capital gains tax, state and local capital gains tax, depreciation recapture tax, and net investment tax.

For federal and state capital gains taxes, the taxable gain is subject to the applicable tax rates. In the example mentioned earlier, a California property owner with a taxable gain of $2,200,000 would owe 20% in federal capital gains tax and 13.3% in state capital gains tax, resulting in a total capital gains tax of $732,600.

Individuals with significant investment and rental income may also be subject to an additional 3.8% net investment tax, which is part of the Affordable Care Act and is added on top of the capital gains rate. Thus, the total capital gains tax bill in California would be 37.1% or $816,200 in the given example. It is important to note that this example specifically pertains to properties and taxpayers located in California, which has the highest capital gains tax rate in the country.

In addition to capital gains taxes, investors are also required to pay depreciation recapture tax. Depreciation deductions are taken annually to offset rental income. These deductions not only reduce the investor's annual tax liability but also decrease the remaining tax basis of the property. When selling the asset at a profit, the investor is required to repay those deductions, which is known as depreciation recapture.

At the federal level, the tax rate for depreciation recapture is a flat rate of 25%. It can also include up to 13.3% for state income tax and be subject to an additional 3.8% net investment income tax. While capital gains tax is calculated based on the taxable gain, depreciation recapture tax is calculated based on the accumulated depreciation during the investor's ownership. Based on the example with $750,000 of accumulated depreciation, the depreciation recapture tax in this scenario could be as high as $315,750.

Deferring Capital Gains Tax with a 1031 Exchange

Real estate investors have a valuable opportunity to defer, reduce, and potentially eliminate capital gains taxes through a strategy called a 1031 Exchange, also known as a "like-kind" exchange. This type of exchange, authorized under Section 1031 of the U.S. Internal Revenue Code, allows real estate investors to defer their tax liability when selling an investment property. In order to defer capital gains taxes, investors must reinvest the proceeds from the sale into like-kind investment property that has equal or greater value.

The term "like-kind" refers to any real estate that is of the same nature or class, rather than the same quality or property type. Essentially, this means that investors can exchange one investment real estate asset for another, as long as it falls under the category of like-kind property. It's important to note that personal residences do not qualify for a 1031 Exchange, as the exchange is limited to investment real estate assets.

The Rules for a 1031 Exchange

A 1031 Exchange is a powerful tool for deferring capital gains, depreciation recapture, and net investment income taxes after selling an asset. However, these exchanges can be complex transactions, and it is crucial to comply with the rules set forth by the IRS. Failure to adhere to these rules can result in a failed exchange or a partial exchange, leading to potential tax liabilities. Before proceeding with a 1031 Exchange, investors should familiarize themselves with the following primary rules:

Improving Cash Flow Potential with a 1031 Exchange

In addition to the tax savings, a 1031 Exchange offers the potential to enhance cash flow and appreciation by allowing the reinvestment of proceeds. Let's consider the example where the investor's total tax liability is $1,131,950. If the post-tax proceeds of $2,118,050 were reinvested and earned a 5% return, it would generate an annual income of $105,903.

However, by opting for a 1031 Exchange, the investor would have $3,250,000 available for reinvestment. Assuming the same 5% return, the exchanged proceeds would generate an annual cash flow of $162,500. This represents a significant difference in cash flow potential, exceeding $56,500. This is one of the primary benefits of 1031 Exchanges – the ability to keep all your equity working for you, generating income and potential appreciation.

By deferring capital gains tax and reinvesting the full sales proceeds into a new property, investors have the opportunity to leverage a larger amount of capital, potentially resulting in higher cash flow and increased investment returns. This enhanced cash flow potential is a key advantage of utilizing a 1031 Exchange as part of a strategic real estate investment plan.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing. Any information provided is for informational purposes only. All scenarios provided for herein are hypothetical illustrations of mathematical principals only, not a promise of performance or success.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication. 

1031 Risk Disclosure: 

Understanding the Distinction: 1031 Exchange vs. 721 Exchange

Understanding the Distinction: 1031 Exchange vs. 721 Exchange

When the term "real estate exchange" is mentioned, most people immediately think of the 1031 exchange. This process is governed by 26 U.S. Code § 1031, which focuses on the "Exchange of Real Property Held for Productive Use or Investment." Its primary objective is to facilitate the "swap" of a relinquished real estate asset for a replacement property. By doing so, investors can defer both depreciation capture and capital gains taxes.

However, it's important to note that there are alternative exchange methods available. Within the tax code, specifically 26 U.S. Code § 721 – "Nonrecognition of Gain or Loss on Contribution," real estate investors have the option to contribute property to a real estate investment trust (REIT) in exchange for a partnership interest in that particular entity. In simpler terms, investors can engage in property exchanges through an arrangement known as an Umbrella Partnership Real Estate Investment Trust, or UPREIT.

While both the 1031 exchange and the 721 exchange offer the advantage of deferring capital gains taxes, there is a key distinction between the two:

Thoughtful young couple receiving expert advice on tax benefits of 1031 and 721 exchanges

In a 1031 exchange, the investor becomes liable to pay capital gains taxes upon the eventual sale of the replacement property. This means that tax obligations are postponed until a future transaction occurs.

Conversely, in a 721 exchange, the investor becomes subject to capital gains taxes when any of the following scenarios take place:

  1. Selling the acquired OP units.
  2. Converting the OP units into REIT shares.
  3. The acquiring operating partnership decides to sell the contributed property.

In addition to the common objective of deferring capital gains taxes, both the 1031 exchange and the 721 exchange offer investors the opportunity to enhance portfolio diversification. By engaging in either of these exchange methods, investors can strategically reposition their assets, allowing for a more balanced and varied investment portfolio. This diversification can contribute to risk mitigation and potentially increase long-term returns.

Moreover, these exchanges hold notable advantages when it comes to estate planning and wealth transfer. Real estate assets are often considered valuable components of an individual's wealth, and both the 1031 exchange and the 721 exchange can play a role in ensuring a smooth transition of wealth to future generations.

By participating in a 1031 exchange, investors can effectively defer capital gains taxes, thereby preserving the value of the real estate asset for the future heirs. This can be particularly advantageous when aiming to maintain the integrity of a family estate or pass on a substantial wealth base to beneficiaries.

Similarly, the 721 exchange allows investors to contribute their property to a REIT and receive OP units in return. This mechanism not only defers capital gains taxes but also facilitates the potential transfer of wealth. The OP units can be transferred to heirs, providing them with an interest in the REIT and, consequently, a stake in the underlying real estate assets. This strategy enables a smooth transition of ownership and allows for the continued growth and preservation of wealth across generations.

Both the 1031 exchange and the 721 exchange, therefore, present investors with viable options not only for tax advantages and portfolio diversification but also for effective estate planning and wealth transfer. These exchanges offer opportunities to structure real estate holdings in a manner that aligns with long-term financial goals and the desire to leave a lasting legacy for future generations. Understanding these additional potential benefits further underscores the significance of these exchange methods within the broader realm of real estate investment.

Financial investment products representing portfolio diversification and tax benefits of 1031 and 721 exchanges

However, the challenge with the 721 exchange lies in finding a REIT interested in accepting the property in the first place, rather than dealing with deadlines or identifying properties of equal or greater value. Once the investor becomes a partner in the REIT through the exchange, they are unable to conduct another deferred tax exchange involving the property sold to that specific REIT. Moreover, investors in the REIT have no voting rights, resulting in a lack of control over the property itself, despite potential passive income benefits.

The key takeaway is that both like-kind exchanges and UPREIT arrangements offer tax-deferral benefits. However, navigating these exchanges successfully requires the assistance of a knowledgeable professional. Understanding the differences, including the absence of strict deadlines in UPREITs and the limited control over the property in 721 exchanges, underscores the importance of seeking expert guidance to ensure compliance with regulations and make informed decisions within the realm of real estate investment.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results.

Speak to your finance and/or tax professional prior to investing. Any information provided is for informational purposes only.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication. 

1031 Risk Disclosure: 

How to Delay or Reduce Capital Gains Tax on a Business Sale

There are multiple strategies to minimize capital gains taxes while selling a business or asset. This article will explore two tax-efficient approaches for structuring a business sale: the Deferred Sales Trust and the Charitable Remainder Trust (CRT). Although they provide capital gains tax benefits, they have distinct purposes.

What is a Deferred Sales Trust?

A Deferred Sales Trust is utilized to postpone capital gains on asset or business sales. It is crucial to note that the DST should not be confused with a Delaware Statutory Trust (DST) as they are distinct entities.

To establish a Deferred Sales Trust, the investor or client sells an asset to a trust that is unrelated to them, and the trust becomes irrevocable. It is critical to ensure that the seller cannot be the trustee or beneficiary or have any control or ownership of the trust to prevent the IRS from classifying it as a "sham trust." This separation creates a third-party transaction, and a corporate trustee, usually an independent third party, manages the trust. The client may also choose an investment trustee in some cases.

Once a Deferred Sales Trust is established, it will operate based on the original agreement. As the client or grantor will have no control over the trust, it is vital to ensure that the trust is created precisely as intended, as it will not be possible to make any changes once established.

The trust sells the business to a third party and receives payment in cash, but from the client's perspective, the business is only sold to the trust. The trust will then make regular payments to the client. The tax deferment is achieved through an installment sale, as per the Internal Revenue Code 453.

The installment payments enable the capital gain to be proportionately spread out, and taxes are only applied to installments instead of a single lump sum sale. The client can specify the amount of the installment payments.

It is important to understand that a Deferred Sales Trust can only delay capital gains taxes and not recapture taxes.

A Deferred Sales Trust can have multiple beneficiaries, including family or charitable organizations. In the event of the grantor's passing, the beneficiaries receive the installment payments.

The trust can invest the proceeds from the sale of the asset, as per the agreements established during the creation of the trust.

However, it is crucial to note that a Deferred Sales Trust cannot be initiated if the investor is already under contract to sell their business, as it must be established before the sale of the asset or business.


What is a Charitable Remainder Trust (CRT)?

While Deferred Sales Trust and CRT share some similarities, a Charitable Remainder Trust (CRT) is a more suitable option for investors who aim to eventually donate their proceeds to a charity or foundation.

A CRT is a tax-exempt trust that is created when an owner donates an asset or business to the trust. The donor receives an immediate tax deduction for the value of the donation. However, the charity may not receive the proceeds for a long time.

The trust sells the business to a third party, and it is not taxed on the sale. However, any gain or ordinary income recognized in the sale is subject to taxation upon distribution to the grantor, i.e., the investor or business owner.

A Charitable Remainder Trust (CRT) has two distribution options: fixed or variable (unitrust). Once the distribution option is chosen, it cannot be changed, making the CRT similar to an annuity. Additionally, like a Deferred Sales Trust, a CRT is an irrevocable trust.

Unlike Deferred Sales Trust, a CRT also offers tax advantages on recapture taxes.

A CRT is not limited to charitable organizations; it can be a private foundation created by the donor, such as a family foundation. However, the donor cannot change their mind and donate to a non-charitable entity, like a family member. The donor receives tax-advantaged income from the CRT, resulting in significant initial and ongoing tax savings.

While the trust may not donate the proceeds to a charity right away, a charity will eventually receive the asset at some point.

To illustrate how a CRT works, consider an example: An investor donates their business, which is worth $1 million, to the trust. The full amount of $1 million goes into the CRT, and the client receives an immediate tax deduction for the amount donated. The trust then sells the business to a third party and invests the proceeds.

The investor can choose between two options for distributing the trust's income: a CRAT, which provides fixed payments, or a CRUT, which provides variable payments based on a percentage of the trust's value. In either case, the investor receives an annual distribution of 5% of the initial amount donated, until the charity eventually receives the remaining amount.

It's important to note that the payments cannot exceed 20 years. Also, the trust can be set up to benefit not just charities but also private foundations, as long as they are tax-exempt. Finally, the CRT offers tax advantages on recapture taxes and creates significant initial and ongoing tax savings for the donor.

A CRAT is a charitable remainder annuity trust that requires fixed dollar amount payments and must pay at least 5% of the initial value.

A CRUT is a charitable remainder unitrust that offers payments as a fixed percentage of all trust assets, ranging from 5-50%. While the percentage option may help hedge against inflation when trust assets increase, payments may decrease if trust assets decrease due to distributions.

Like a Deferred Sales Trust, the donor establishes the trust rules as long as they comply with the Internal Revenue Code. Once established, the trust rules cannot be changed due to the irrevocable nature of the trust.

Both the Deferred Sales Trust and CRT offer tax deferral options for the sale of a business or asset but require an attorney for proper setup. Failure to set up the trust correctly may result in costly penalties and interest, so it's best to work with an estate attorney with a strong tax background.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing. Any information provided is for informational purposes only.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

The History of Delaware Statutory Trusts

Commercial real estate, which has been regarded a "alternative" asset sector for a long time, has historically presented substantial entrance barriers. Due to the expense, inaccessibility of property information, and danger connected with purchasing properties individually, only the wealthy could enter the market. This comprises institutional investors such as life insurance companies, endowments, and pension funds, in addition to family offices and individuals with an extraordinarily high net worth. DSTs, or Delaware Statutory Trusts, have begun to level the playing field.

Today, DSTs enable individuals to invest fractionally in a trust's assets, which may include one or more pieces of commercial real estate. The sponsor of the DST is then responsible for the day-to-day management of the trust's properties on behalf of the investors.

Moreover, unlike investing in a syndicate or fund, DSTs have been considered "1031 Exchange eligible," meaning that people can sell their own investment property and reinvest the proceeds into a DST to defer capital gains tax. Thus, it is not surprising that DSTs are rapidly gaining favor.

But DSTs did not merely appear suddenly. Their arrival was a lengthy process. This article examines the history and origin of Daylight Saving Time.

The History of DSTs

Historically, wealthy Americans have utilized trusts to transfer property from one generation to the next. Using a trust provides tax and security advantages that would not otherwise be available.

The majority of these trusts are housed in Delaware, a state renowned for being business-friendly and tax-friendly. Since at least 1947, Delaware common law has recognized business trusts. This is why a large number of Fortune 500 firms put their headquarters in the state. Trust income, including capital gains, has been exempt from taxation for decades, even trusts controlled by non-residents. In other words, out-of-state residents can take advantage of Delaware's trust tax laws just as easily as Delaware residents.

In 1988, Delaware formalized its common law on trusts and became the first state to establish an effective and judicially protected legal entity: the Delaware Statutory Trust (DST). The Delaware Business Trust Act of 1988 provides specific guidelines for the operation of trusts. This gave investors the assurance they required to invest with confidence in DSTs.

Several other states have since enacted legislation governing trusts, but Delaware remains the jurisdiction of choice for trustees due to the breadth and clarity of its corporate entity rules. In addition, the Court of Chancery and the Supreme Court of Delaware have gained a reputation for excellence due to their extensive familiarity with commercial matters, which results in the efficient, fast, and equitable resolution of disputes. Today, there is a vast body of Delaware case law from which people seeking trust-related assistance might draw.

The Delaware Business Trust Act (DBTA) was renamed the Delaware Statutory Trust Act (DST Act) in 2002. (Title 12, Ch. 38 of the Delaware Code). The DST Act expressly authorizes the establishment of DSTs and stipulates rules governing their internal operations. The DST Act recognizes DSTs as distinct legal entities that may engage in any legitimate business or activity. The regulations further indicate that a DST will not terminate or dissolve due to the death, incapacity, dissolution, termination, or bankruptcy of a beneficial owner, unless the Trust Agreement specifies otherwise. DSTs are also permitted to obtain funding in their own name as opposed to in the names of their individual trustees.

The DST Act also specifically limits the trustee's obligation. The Act provides that a trustee "must not be personally accountable to any person other than the statutory trust or a beneficial owner for any act, omission, or obligation of the statutory trust or any trustee thereof," unless otherwise expressly stipulated in the trust's governing instruments. This provision provides trustees with great protection; they can rest easy knowing that the possible liabilities they may face as a result of investing in a DST are strictly limited, whereas indemnity affords them extensive protections.


DSTs vs. TICs

The DST Act of 2002 effectively provides the necessary advice and protections for persons interested in fractional investments in commercial real estate. Prior to this, the majority of co-investors in real estate utilized a tenant-in-common (or "TIC") structure.

Those who invest in a TIC hold a partial interest in the property's title. As a result, each owner is personally accountable for any debt incurred to acquire or enhance property held by a TIC. TICs can have up to 35 individual co-owners, therefore the procedure of underwriting each individual investor might make financing a TIC more difficult than financing DST investments, because the loan is backed by the DST itself and not by individual investors.

Moreover, each major investment decision involving TICs requires unanimity among co-investors. Even in the best of times, this makes decision-making difficult. Important decisions required to develop the TIC's business plan and investment strategy can be halted by a single holdout.

Despite the obvious benefits of investing in a DST as opposed to a TIC, many continued to favor the latter until the middle of the 2000s. This is because industry groups, including some of the nation's top commercial real estate sponsors, urged the IRS in the early 2000s to adopt criteria that would allow TIC real estate to qualify for 1031 exchanges (IRS Revenue Procedure 2002-22). Those who sold their own investment property could then reinvest the sale proceeds into a TIC to delay paying capital gains tax (sometimes, indefinitely).

This led to a record number of people investing in TICs. 2007 marked the peak of the TIC business, when about $4 billion of equity was invested using TIC structures. Nonetheless, many of these investors quickly realized the flaws of the TIC framework.

DSTs gained popularity at the same period, partly due to the inefficiencies of the TIC paradigm. The IRS implemented comparable 1031 exchange standards for DSTs in 2004. Revenue Ruling 2004-86 permitted the use of the DST structure for the acquisition of real estate where the beneficial interests of the trust would be recognized as direct interests in replacement property for purposes of a 1031 exchange. Investors in the United States rejoiced.

Co-Investment in Real Estate During the Great Recession

When the Great Recession struck in 2008, both TICs and DSTs suffered a severe blow. The investment in syndicated real estate plummeted. TICs were hit worse than DSTs. In 2009, less than $250 million was invested in TICs, which represents approximately 6.25 percent of the equity contributed just two years previous. In general, lenders grew more prudent. Due to the necessity to evaluate each investor's creditworthiness, a minuscule number of people desired to invest in TICs. The effort required by banks to establish loans on TICs (which, again, might have up to 35 individual investors) simply became too burdensome.

Investment in TICs and DSTs remained stagnant over the most of 2013. As the economy began to recover, DSTs became the favored form for co-investment. By 2015, DST investment had regained its pre-recession level and has risen steadily since then. In 2020, around $3.20 billion in equity was raised for DST investments, a surprising amount given the remaining anxiety among investors caused by COVID.

Future Prospects for DSTs

Investing in DSTs could continue to be robust in the future. There is a backlog of investors who are eagerly awaiting the end of the pandemic before selling their property. Many of these investors may use 1031 exchanges to avoid paying capital gains tax, and many of them may invest in DSTs to do so. Cash investors are diversifying their portfolios by expanding their DST investments. DSTs are a fantastic alternative for accredited investors wishing to invest in fully passive real estate due to the variety of associated potential benefits, including asset and geographic diversity.

Already, it appears that 2021 will be a good year for DST equities investments. This could continue throughout the coming months and years, barring any unforeseen occurrences.

Are you curious to find out more about DSTs? Contact us immediately to learn more about our investing strategy, 1031 exchanges, and DSTs.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. Information herein is provided for information purposes only and should not be relied upon to make an investment decision. All investing involves risk of loss of some, or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

1031 Risk Disclosure:

Identification Rules for a 1031 Exchange

So you've decided to perform a 1031 exchange after selling or considering selling your investment property. Anyone selling investment property is given 45 calendar days to find a replacement property or properties under Internal Revenue Code (IRC) 1031. But are you aware of the identification rules, 45-day alternatives and other regulations?

The new property or properties do not have to (yet) be under contract; nonetheless, you must identify them to your accommodating/qualified intermediary during the 45-day period. Following the close of the property that you just sold, the 45-day countdown begins. You have a total of 180 days starting from the closing date of the property you gave up to close on the new property or properties you chose.

Some people find the 1031 identification process potentially more easier and simpler to comply with in reference to their investment property exchange, which is one of the reasons why many people opt to use Perch Wealth's DST platform.

What then are the different choices that investors have when identifying?

Three-property rule

The investment taxpayer may list up to three properties under the three-property rule, regardless of the fair market value of the assets. If you apply this criterion, you are not required to buy all three of the properties you mention, but you must close on at least one of them.

The three-property rule should not be relied upon if you wish to diversify your real estate investment dollars, for instance by investing in DSTs, and you want to find more than three potential assets.

200% rule

A 1031 exchange investor is allowed to find and close on any number of properties as long as the total fair market value of the properties found during the 45-day period does not exceed 200 percent of the total fair market value of the relinquished property at the time it was sold, according to the 200% rule. If you sold your home for $1,000,000, for instance, you may name as many properties as you wanted as long as their combined fair market value did not exceed $2,000,000.

95% rule

As mentioned in the alternatives above, if an investor finds that they need to identify more than three properties and more than 200% of the total value, they can rely on the 95% rule. However, exercise caution because the 95% rule might be difficult to follow because it calls for the investor to close on at least 95% of the selected properties. Since it is nearly impossible to achieve the 95% criteria, the three-property or 200% requirements will often apply to almost all investors.


What details must you give your accommodation provider or certified intermediary (QI)?

The street address, assessor parcel number, and/or legal description can all be given to your QI. Ensure the accuracy of this. Be as explicit and clear-cut as you can.

Remember to pay special attention to the aforementioned guidelines since failure to do so may result in the IRS and/or state tax agency disallowing your exchange in the event of an audit. Beginning to consider your DST replacement properties before you sell your relinquished property will significantly help in potentially minimizing any stress generally associated with adhering to the 1031 exchange laws. Early planning is crucial.

Work with a DST investing firm that is well-versed in how to advise you through this procedure as well as an experienced and knowledgeable qualified intermediary. You can get assistance from the Perch Wealth experts with your 1031 exchange. Perch Wealth might potentially aid in making sure that your 45-day ID period goes easily and effectively by employing and investing in the DST structure.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. Information herein is provided for information purposes only and should not be relied upon to make an investment decision. All investing involves risk of loss of some, or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

1031 Risk Disclosure:

BD vs. RIA: Who to Consider for a 1031 Exchange

Investors looking to speak with a qualified professional about their 1031 exchange investment options can opt to work with a broker-dealer (BD) or registered investment advisor (RIA). While both BDs and RIAs can typically offer similar services, the scope of their expertise and fees can vary drastically. In this article, we define the difference between a BD and an RIA in the hopes of helping you determine which professional is a better fit for you.

What’s the difference?

RIAs are individuals or firms that typically focus on offering general financial advice, managing clients’ accounts, and executing stock trades for clients. RIAs generally charge an annual fee equal to a percentage of the assets they manage on behalf of their clients. 

BDs, on the other hand, primarily work to facilitate investment transactions for their clients. Fees are generally commission-based, meaning BDs typically charge a one-time fee for each transaction they facilitate rather than an ongoing fee.

The Relevance of a 1031 Exchange

Investors looking to sell their real estate and trade into a like-kind alternative investment should work with a qualified professional – either a broker-dealer or a registered investment advisor.

Today, one of the most common examples of a 1031 exchange is trading from a real estate property into a Delaware Statutory Trust (“DST”).

A DST “is a legally recognized real estate investment trust in which investors can purchase ownership interest. Investors who own fractional ownership are known as beneficiaries of the trust – they are considered passive investors. … Properties held in DSTs that are considered ‘like-kind’ include retail assets, multifamily properties, self-storage facilities, medical offices, and other types of commercial real estate.”


These one-time transactions enable investors to sell their real estate and buy into a qualified investment while deferring capital gains. Furthermore, by trading into a DST, investors can access institutional quality assets they otherwise may not be able to purchase, leverage excellent financing obtained by a DST sponsor, access passive income potential that is management free, and limit their liability in the investment.

To better understand how trading into a DST works, it’s best to compare a DST to a real estate exchange rather than an equity purchase – there is a significant difference between the two when determining how much an investor should pay in fees.

Avoiding Potentially False Claims

Why is this important when deciding who to work with – an RIA or BD?

Today, many claims are often presented in an effort to win business from investors in a 1031 exchange or from those looking to place cash into a DST. Many RIAs claim it is cheaper to work with them than a BD because their commissions are waived. However, this claim ignores the fact that RIAs typically charge clients an ongoing annual fee. This fee has the potential to cost you more over time. It’s important to do your research to find out what the ongoing fee is, as well as what, if any, additional services you are receiving for that fee. Of note is the fact that the ongoing fee is typically calculated as a percentage of the value of the assets. That means that if the asset appreciates, you will be paying more, and if the asset depreciates, you'll be paying less.  As a result, it isn't possible to determine the exact cost of the advisory fee over time.

Let’s look at an example.

Say that an investor trades out of a retail property into a DST, an investment that will generally last for five to ten years before the investment is sold and the investor can do another exchange. Assume the investor puts $1 million into the DST. Now, let’s look at how much a BD would cost versus an RIA. If the BD charges a 6% commission on the investment, that results in a commission of $60,000 on the transaction. An RIA, on the other hand, charges a percentage of the assets under management (AUM) – in this scenario, the AUM is $1 million. Now, let’s say the RIA fee is 1.5% of the Assets Under Management (“AUM”). An investor would then pay $15,000 per year to the RIA for the investment (assuming the asset value remains stable). Based on the average holding period of a DST (five to ten years), the investor would pay between $75,000 and $150,000 for the exchange! Of course, in the event the DST sponsor exits early, or you are presented with an opportunity to liquidate/exchange early, that could result in a potentially lower fee.


Broker-Dealers May Cost Less than Registered Investment Advisors

The above model simply shows the cost difference between working with a BD and an RIA and outlines how working with a BD may be less expensive than working with an RIA. In the above scenario, the investor pays 50% to 250% more to work with an RIA than a BD. Imagine if an investor had millions to invest.

Don’t Pay Annual Fees on Passive Investments like DSTs and Other 1031 Exchange Investment Options

DSTs and other 1031 exchange investment options are set up as management-free investments, meaning no management responsibility is required of the investor or the one representing the investor in the transaction. Instead, sponsors manage these alternative investments on behalf of their investors completely; therefore, they are entirely passive. Why pay an RIA to “manage” your DST investment when it is already being managed for you?

Understanding the Options in a 1031 Exchange

Before jumping into any investment, an investor should conduct due diligence to fully understand the available options and associated fees. If an investor is choosing between an RIA and a BD, they should ask themselves who has more knowledge about the investment and whose fees align with the type of investment they are considering. These questions may help investors protect themselves and their capital in future investments. 

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. Information herein is provided for information purposes only, and should not be relied upon to make an investment decision. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

1031 Risk Disclosure:

How Real Estate Investing May Shield You From Inflation

The term "inflation," which refers to the slow increase in the cost of products and services over time, has recently appeared in the headlines of all of the main business news outlets. Everyone was only interested in discussing how dramatically and finally the U.S.'s historically low inflation rate was coming to an end. Used car prices were breaking records, timber costs were skyrocketing, petrol prices appeared to be moving up, and food prices were higher than they had ever been.

Although the precise reason for price increases is still up for debate, it is no longer a secret that the cost of necessities like food and shelter is growing. Inflation is presently influencing the life and job of the typical American, and, while it stays genuine that we have encountered a lucky and broadened time of low inflation, it seems like all beneficial things do, as a matter of fact, reach a conclusion - - and presently is essentially the finish of inflation 's record lows.

The ramifications of high, or rising, inflation costs for financial backers is that high inflation can influence the worth of a future stream of income. Consequently, financial backers need to accomplish returns that are higher than the pace of price inflation. This implies that now, like never before, financial backers ought to get ready to change their venture techniques pushing ahead and carefully plan to support against inflation.

In this article, we'll define inflation, examine how it tends to be a headwind for financial backers, and foster one center thought: that land money management is possibly the support expected to safeguard yourself from inflation, as well as the deficiency of buying influence that outcomes from it.

What is inflation?


inflation is the slow inflation in the cost of labor and products after some time. It is estimated by observing changes in the Consumer Price Index, which is based on a record of normally bought goods and services. The U.S. Central bank is liable for setting financial approach, and inflation is quite often one of its essential worries.

The Federal Reserve for the most part attempts to oversee inflation to a specific objective (around 2-3% every year), however it saves the capacity to go to activity when price inflation lengths above or underneath this reach.

The most recent report from the U.S. Department of Labor Statistics shows that the Consumer Price Index (CPI), which is one proportion of inflation, has increased 5% throughout the last year alone. That is the most noteworthy increment beginning around 2008, which was, uncoincidentally, the last time the nation was in a monetary emergency.

How could inflation be a headwind for financial backers?

Inflation can be harming to financial backers' capital since they need to accomplish returns that are higher than the pace of economic inflation.

A model can be utilized to all the more powerfully come to this meaningful conclusion.

On the off chance that inflation is running at a pace of 3% yearly, and a financial backer keeps her capital in a currency market account that pays a proper pace of revenue at 2% yearly, she is really losing 1% of her buying power every year - - comparative with inflation. Over the long haul, the financial backer's capital can buy less on the grounds that the expense of labor and products has risen quicker than her speculation returns.

To stay away from a circumstance like this, financial backers ought to consider searching out inflation fences or resource classes that are exceptionally situated with the possibility to perform well in times of high economic inflation.

Real estate-centered financial planning may be the hedge you really want to shield yourself from inflation.

For what reason is real estate viewed as a decent hedge against inflation?

There are various reasons. As far as one might be concerned, one could analyze the impact of inflation on obligation. As a home's cost ascends after some time, it brings the credit down to worth of any home loan obligation, going about as a sort of regular markdown. Thus, the value on the property increments, yet your fixed-rate contract installments continue as before.

Inflation can likewise possibly help land financial backers who procure pay from investment properties, explicitly property areas with momentary rent structures, as multifamily lodging networks, on the grounds that higher home costs frequently compare to higher lease structures. In the event that a land financial backer can change her/his lease up while keeping the home loan something similar, this sets out the freedom for expanded cash in the financial backer's pocket.

At last, land might possibly be a decent support against inflation since property estimations after some time will generally stay on a consistent vertical bend. The vast majority of the homes that hit absolute bottom when the land bubble burst in 2008 returned to their pre-crash costs in under a solitary 10 years. Land speculations can likewise turn out expected repeating revenue for financial backers and can keep speed or even surpass inflation with regards to appreciation.

Since the proof gives off an impression of being supportive of land, and it being a resource class that has generally held its own when confronted with increasing inflation rates, we should now direct our concentration toward a couple of procedures commonly used to endeavor to fence land ventures against inflation.

How might you possibly involve real estate as a hedge?

Potentially one of the most mind-blowing ways of utilizing land to support against inflation is to put resources into a multifamily property. Different kinds of properties, like business structures (like retail locations), have their inhabitants sign long term business leases. Multifamily lodging for the most part recharge rents exclusively with each occupant one time per year. The more units a structure has, the more regularly you're given sufficient chances to change the lease. The equivalent is valid for self-capacity.

What's more, multifamily properties, for example, apartment buildings are a one of a kind resource class in that they are commonly consistently popular, particularly while lodging costs take off. Furthermore, because of late inflations in labor and material expenses, there is a restricted stock of structures or new improvement projects, which can make an ascent in rental rates and property estimations. Together, these two elements equivalent a property that can possibly not be empty for significant stretches of time and various openings to restore or begin leases at market-changed rates.

Another thing to consider is that cost repayments, another rent part, is an extra way land money management can possibly pace inflation. Leases pass some type of a property's ongoing working costs down to their occupants, no matter what the kind of building structure. As utility and support costs ascend because of inflation, landowners or building proprietors can be undoubtedly somewhat protected from the impacts on the property's income.

It is clear, then, at that point, that real estate investing - - especially putting resources into multifamily lodging properties - - might possibly be a decent fence against inflation that our ongoing business sector brings to the table. Land effective money management is in many cases thought about a way towards reserve funds safeguarding in an inflationary and capricious economy.

It's very simple to see the reason why financial backers have rushed to real estate in the midst of monetary vulnerability. No matter what, lodging will continuously be required, and hence, probable sought after. A speculation property that is bought and clutched for the long haul can possibly be a safe method for developing the first interest into something more significant not too far off.


On the other hand, in the event that financial backers can't - - or just don't have any desire to - own and deal with the venture property themselves, they can consider land trusts (REITs), intuitional land assets, and Delaware Statutory Trusts (DSTs). How one chooses to go about land money management is completely dependent upon them; it is, and ought to be, an individual monetary choice. In any case, it very well may merit your time and energy to educate yourself pretty much all regarding your choices and survey from that point - - or talk with a learning experience master like the group at Perch Wealth.

Why putting resources into a DST can be an alluring choice

In the event that your main concern is to look for abundance safeguarding during an inflationary financial period, then, at that point, putting resources into a Delaware Statutory Trust, or DST, is possibly a very appealing land venture choice. A DST is an ordinarily involved structure for those looking to partially put resources into land.

A DST is a way for financial backers to possess land with the chance of procuring recurring, automated revenue and zero administration obligation. Most financial backers don't commonly consider whether they are keen on dynamic versus aloof responsibility for domain property, and thusly, get into circumstances that they believe they aren't equipped for, intrigued by, or profiting from in the ways that they might want to be. For a first-time frame or moderately new financial backer, putting resources into a DST is an incredible prologue to a possibly recurring source of income and collection of uninvolved riches.

There are two essential ways that an individual can put resources into a DST. The first is through an immediate money speculation. For instance, perhaps you're new to land effective money management and just need to secure your opportunity; you could hope to put $50,000 in a DST to acquire a traction in the land business. The second is by using a 1031 Exchange.

Numerous financial backers are really ignorant that they can use a 1031 Exchange to put resources into a DST, however there are numerous potential advantages to doing as such. By doing a 1031 Exchange, you can probably expand the ongoing level of the housing market and differentiate your assets into various DSTs that are geologically shifted and in particular resource classes, assisting with moderating and conceivably limit the general gamble to your capital. Assuming that you're keen on finding out about 1031 Exchanges, DSTs, or more elective land speculation systems, you can talk with one of Perch Wealth's financial experts today.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. Information herein is provided for information purposes only and should not be relied upon to make an investment decision. All investing involves risk of loss of some, or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

1031 Risk Disclosure: