Nationwide,
Toll-Free:
866-694-0204 |
|
|
 |
IRS Approves Delaware Statutory Trusts as a 1031 Exchange Vehicle
One
of the basic requirements
of
a 1031 exchange is you must take title to the New
Property in the same way you held title to your
Old Property (i.e. the same tax return). For example,
if you held title to your Old Property as Fred
Jones, you could not take title to the New Property
as Jones Investment Corporation because your
Old Property was owned by your Federal 1040, whereas
the Corporation files a different tax return (which
will invalidate the exchange).
 |
by
Gary Gorman
Founding Partner,
The 1031 Exchange Experts |
|
The
IRS has a list of what they call "disregarded entities"
which you might think of as exceptions to the rule
(they are actually clarifications). One of these
disregarded entities is a revocable living trust.
If you own property in a revocable living trust,
you know that the trust does not file an income
tax return. All of the rents, dividends, interest,
expenses, etc. arising from assets owned by the
living trust are reported in your individual 1040.
So, if Fred Jones owns his Old Property in the name
of the "Jones Revocable Living Trust," he can sell
it, do an exchange, and buy the New Property as
"Fred Jones" because the same tax return owns both
the Old Property and the New.
Prior to this new ruling, in addition to revocable
living trusts, there were two similar types of disregarded
entities: "Illinois Type Land Trusts" and "Single
Member Limited Liability Companies" (LLCs). An Illinois
Type Land Trust is a certain type of trust where
the property is held in the name of the trust, but
the multiple owners of the trust are considered
the true owners -- the trust does not file a tax
return. If there are three owners, then three tax
returns own the property for 1031 purposes. If Fred
is one of the owners, he can sell his share and
buy the New Property as "Fred Jones," again because
it is all the same tax return. The problem is Illinois
Type Land Trusts do not protect the owners from
personal liability.
|
|
|
|
| |
| As
appeared in... |
|
 |
September
1 , 2004 |
|
|
|
|
|
|
|
|
|
|
|
|
LLCs do protect you from liability, but they file a
partnership tax return separate from the individual
members.
There
is no such animal, however, as a single-partner partnership.
Therefore,
if you try to file a tax return for an LLC with only
one owner, the IRS will send it back and tell you to
report the income and expenses on your own individual
tax return. If Fred Jones sells his Old Property, he
can buy the New Property as "Jones Investments, LLC"
if he is the only member, because again, it is all the
same taxpayer.
The
problem has always been that if three people want to
buy a property together, the lender will probably want
them to take title as a "single purpose" or "bankruptcy
remote" entity. The reason this is a problem is that
if any of the three are trading into the property, a
single purpose entity will not satisfy their exchange
requirement because it files its own return. Likewise,
when they sell this property, the three are joined at
the hip by the single purpose entity: either they all
do an exchange, or none of them do an exchange.
The good news is that the IRS has just approved the
Delaware Statutory Trust (called a "DST;" also called
a Delaware Business Trust) as a fourth disregarded entity
for holding 1031 exchange property. This is truly a
great benefit for 1031 exchange investors because DSTs
are the best of all worlds: they combine the flexibility
of an Illinois Type Land Trust with the asset protection
benefits of an LLC.
Going back to my example of the three investors that
wish to buy a property together, a DST will provide
the single purpose, asset protection vehicle that a
Land Trust can't because a DST is bullet proof like
an LLC. At the same time it provides for multiple separate
owners just like a Land Trust.
|
|
|
|
So three of you want to buy a building. You set up a
DST which becomes the legal, registered owner of the
building and is the bankruptcy remote borrower which
satisfies the bank's loan requirements. AND for income
tax purposes, the building is owned by three separate
tax returns, which satisfies your 1031 exchange requirements.
...DSTs
are the best of all worlds: they combine
flexibility with asset protection... |
|
The
DST must have a "Trust Agreement" in place which defines
the relationship of the three owners (just as you would
have a partnership agreement or an LLC operating agreement).
This trust agreement can be tremendously flexible because
there are few requirements governing the agreement,
and the agreement does not need to be filed with the
state of Delaware. Furthermore, DSTs are not taxed by
the state of Delaware.
There are a couple of hoops that you do have to jump
through: first, you can own property in the DST, but
you can not operate a business in a DST (a DST can own
the Burger King building, but it can not make the hamburgers).
Second, you have to have a Trustee for the DST, and
the Trustee has to be a resident of the state of Delaware.
The Trustee can not take independent action to buy,
sell, lease or finance the property, but can be directed
to do these things by the owners. And the owners can
not directly collect the rent and pay the bills, but
can direct the Trustee to hire a management company
to do so.
I
predict that DSTs will become a key component of the
1031 industry.
If
you would like to learn more about DSTs,
call The 1031 Exchange Experts, and
we'll be glad to discuss them with you in
detail. |
|
|
|
|
