Why Delaware Statutory Trusts (DSTs) Make Popular Real Estate Tax Deferral Solutions

Real estate can be a powerful asset to build your wealth and provide financial independence.  However, there may come a time when the “Three T’s” of real estate investing – Tenants, Trash, and Toilets – becomes old. While selling and sailing off into the sunset can appear alluring, the thought of settling up with the taxman can throw cold water onto the face of that dream. Fortunately, the tax code provides savvy real estate investors several options to sell, defer or eliminate capital gain taxes and maintain an income stream.  A few possibilities include Delaware Statutory Trusts, Qualified Opportunity Funds, and Charitable Remainder Trusts.

In this article, we will explore Delaware Statutory Trusts (DSTs). DSTs can allow an accredited investor to say adios to the Three T’s while also putting off, and potentially eliminating, the unpleasant notion of settling with Uncle Sam.

WHAT IS A DELAWARE STATUTORY TRUST?

A Delaware Statutory Trust is an investment trust that you can use for real estate ownership of high-quality, professionally managed commercial properties that provide a passive, turn-key solution for completing a 1031 Exchange.

Investors in a DST are not direct owners of real estate.  Instead, they own an undivided interest in the assets held by the trust.

The Delaware Statutory Trust holds title to the property for the benefit of the investors.  Each DST is established and managed by a “sponsor.” 

DSTs QUALIFY AS A 1031 LIKE-KIND EXCHANGE

The 1031 “like-kind” Exchange allows a real estate owner to defer capital gains (and depreciation recapture) taxes on a property sale when they use the proceeds to reinvest in qualifying properties.  If exchanging into direct ownership of another property, you defer the taxes, but the Three T’s remain the investor’s responsibility.  

The IRS recognizes Delaware Statutory Trusts as qualified replacement property for a 1031 Exchange.  By owning an undivided interest in the trust assets, the investor can enjoy the benefits of real estate ownership without the hassles of being a landlord.

OTHER ADVANTAGES OF DELAWARE STATUTORY TRUSTS OVER DIRECT PROPERTY OWNERSHIP

Institutional Quality Real Estate. DST’s allow real estate investors access to large, high-quality commercial properties that may otherwise be out of their reach. Partnering with a respected sponsor with better access to institutional quality properties and expertise in property management can help you expand your options when looking for replacement property.   

Diversification. Diversification helps to minimize risk in your investment portfolio. Many real estate investors tend to focus on one asset class, such as multi-family properties.  Delaware Statutory Trusts provide you the opportunity to own a diversified real estate portfolio (e.g., warehouses, storage, essential retail, etc.).   Additionally, DSTs can help you diversify your real estate portfolio geographically through ownership of quality properties in several areas of the country.  For example, you can sell one property in Chicago, IL, and exchange the proceeds into multiple Delaware Statutory Trusts that own warehouses in Austin, TX, multi-family properties in Denver, CO, essential retail in Nashville, TN, self-storage in Tampa, FL, etc.

Passive Income. Many real estate investors want or need to replace the income stream from their investment property. A DST portfolio can provide you an income from multiple properties that can potentially meet or exceed the net income from the sold property.  Most Delaware Statutory Trusts distribute income monthly.  Passive income without the hassles of direct property ownership can be an attractive exit strategy for property owners. 

Estate Planning Flexibility. You may prefer to manage your real estate property actively. Your spouse or heirs may not know how to take over that responsibility if something happens to you. DSTs can be a powerful estate planning tool because you can divide your interests amongst beneficiaries leaving each to decide what to do with their portion. Furthermore, the cost basis on the properties steps up to fair market value upon your death.

Closing with Confidence. Investors trying to complete a 1031 exchange can face uncertainty when identifying properties for an exchange and closing on the purchase within the required timeframe. Investing in Delaware Statutory Trusts may remove the uncertainty and hassle from the process. The Delaware Statutory Trust sponsor is responsible for doing the heavy lifting involved in setting up and managing the trust. You can close on the purchase of DSTs in short order compared to the time it often takes to close on a direct property purchase.  This allows you to seamlessly transition from selling your property into owning a diversified Delaware Statutory Trust portfolio.

Possible Disadvantages. DSTs are illiquid investments and therefore are only appropriate for long term investment horizons.  A typical DST may be liquidated by a sponsor after 5 to 10 years, and the investor will then have the option to exchange into another qualifying replacement property or to receive cash and pay any taxes due at that time.  Also, Delaware Stutory Trusts are only available for accredited investors.  Please read the disclosure at the end of this article.

Click here to read about other potential benefits of owning DSTs

DSTs can offer accredited investors some unique opportunities.  Under the right circumstances, they can be an effective solution for real estate investors looking to eliminate the dreaded Three T’s of being a landlord while deferring or eliminating taxes, maintaining a rental income stream, and continuing to enjoy the benefits of property ownership.   Consulting with an elite wealth manager who understands the unique needs of real estate investors can help you determine if owning Delaware Statutory Trusts is appropriate for your objectives.

DISCLOSURE & ACKNOWLEDGEMENT

To be an “accredited investor,” an individual must have had earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years and “reasonably expects the same for the current year.” Or, the individual must have a net worth of more than $1 million, either alone or together with a spouse, excluding one’s primary residence

The information included in this material is for informational purposes only and should not be relied upon for any financial or legal purposes. Arlington Capital Management Inc, dba Arlington Wealth Management (AWM) is an investment adviser registered with the U.S. Securities and Exchange Commission.  Our registration with the SEC or with any state securities authority does not imply a certain level of skill or training, nor are we selling you any product.  Rather, we are seeking to provide you with advisory services.   Please consult with your own tax and legal advisers before investing. AWM cannot and does not guarantee the performance of any investment.  Past performance is no guarantee of future results.

What Types of Charitable Giving Accounts Might Be Best for My Family?

The variety and complexity of charitable giving options can be overwhelming.  A wealth manager with expertise in charitable giving can help guide you to an intelligent philanthropic approach. So put away the checkbook, and let’s review two charitable giving options: Donor-Advised Funds and Charitable Remainder Trusts. 

An increasing number of families and business owners want to support the causes they care about, both while they are alive, and after they pass. For charitable-minded families, several gifting vehicles not only help you better meet your philanthropic goals but can also help you address other important issues –  reducing taxes, increasing cash flow, transferring wealth efficiently, and protecting your assets.  The optimal charitable strategy for you will depend on your values, goals, and objectives.

DONOR-ADVISED FUNDS

A Donor-Advised Fund is a 501c(3) charity organization that receives donations from you, allows you to invest those contributions, and specifies whom you want to grant your gifts. Donor-Advised Fund accounts are easy to use. Most large brokerage firms such as Charles Schwab, Fidelity, and Vanguard have user-friendly client portals, which can come in handy if you donate to several charities.

With a Donor Advised Fund, you receive an immediate tax deduction when you fund the account, and the account can grow tax-free based on the performance of the investments selected. It is typically best to fund the account with appreciated assets you would otherwise pay capital gain taxes on the sale because you eliminate capital gains tax. Tax mitigation is the main reason people chose donor-advised funds as a charitable gifting vehicle.

Some firms that offer donor-advised funds have account size and donation minimums, so you will want to find out what they are before opening your account. Once you fund the account, the invested money remains in the account until you decide which charities make gifts, which could be at any time, even years down the road.

CHARITABLE REMAINDER TRUSTS (CRT)

A Charitable Remainder Trust can generate an income stream for yourself or any person(s) you choose. You can design the income to be for a set period or your lifetime. Once the trust disperses the funds to the named beneficiaries, the trust gifts the remaining assets to charities that you choose. It also provides you an immediate charitable deduction in the year you fund the account.

A Charitable Remainder Trust has several potential benefits.  First, it helps fulfill your charitable gifting goals.  Second, it helps provide income for your living needs or any person(s) you choose.  Third, the trust assets grow tax-deferred.  Additionally, you are eligible for an immediate tax deduction to help offset other taxable income.  Finally, the assets are removed from your estate, potentially helping to reduce estate taxes.

There are two caveats in a Charitable Remainder Trust you should understand.  You have to select the charities when you establish the trust, years before the gift will occur. For this reason, some people will choose their donor-advised fund as the charitable beneficiary of the trust because they can have more control over naming and changing charities that receive the remaining funds.  Also, the trust is irrevocable, meaning that you cannot change your mind once the assets are transferred to the trust.  You give up ownership of the assets in return for the potential income stream.

THERE ARE TWO DIFFERENT KINDS OF CRTs:

Charitable Remainder Annuity Trust (CRAT) and a Charitable Remainder Unitrust (CRUT)

A CRAT will pay a fixed dollar amount to the person you designate for a set number of years, with a maximum of twenty years. For example, you can select the amount at $45,000 annually.  You cannot change the payout amount once set even if the trust assets grow more than the distribution.  You also cannot add future assets to a CRAT once it is established.

A CRUT pays a set percentage of the trust assets each year, instead of a fixed dollar amount in a CRAT. For example, you can choose to pay out 7% of the trust assets annually.  The income stream varies each year based on changes in the trust value as it increases or decreases. The annual payment increases or decreases with the value of the assets in the trust.

WHAT ARE THE BEST ASSETS TO GIFT?

Your best option is to gift appreciated assets (stocks, real estate, private business shares, etc.) that will otherwise incur a capital gain tax upon the sale.  Once you make the gift with the appreciated assets, you eliminate the capital gain tax liability.  The charitable giving vehicle – Donor-advised fund or Charitable Trust – sells the investment in a tax-exempt structure.  Compare this strategy to first selling the asset, paying the tax, and then gifting cash. Ideally, you will never make charitable gifts with cash. 

Affluent families practice intelligent philanthropy using IRS-approved tools to make more impactful charitable gifts while also improving their financial security.  You don’t have to be ultra-rich to benefit from the same strategies.  Make sure your advisor is knowledgeable with philanthropic planning or has access to experts in this field.  

Charitable Trusts and Donor-advised funds can be wise options to help you meet your philanthropic goals.  These charitable giving vehicles can also improve your personal finances significantly with the potential for increased income streams and reduced taxes. 

DISCLOSURE & ACKNOWLEDGEMENT:

The information included in this material is for informational purposes only and should not be relied upon for any financial or legal purposes. Arlington Capital Management Inc, dba Arlington Wealth Management (AWM) is an investment adviser registered with the U.S. Securities and Exchange Commission.  Our registration with the SEC or with any state securities authority does not imply a certain level of skill or training, nor are we selling you any product.  Rather, we are seeking to provide you with advisory services.   Please consult with your own tax and legal advisers before investing. AWM cannot and does not guarantee the performance of any investment.  Past performance is no guarantee of future results.

Little Known Ways for Business Owners to Reduce Taxes

Business owners have numerous ways to reduce their tax bills for both themselves and their companies.  Some of the methods are more commonly understood; however, many tax strategies are relatively unknown to even the brightest of entrepreneurs. 

Little-known tax strategies are not a secret because they are written in the tax code and approved by the IRS.  Wealth managers, accountants, and tax attorneys should all know about these and other ways for you to avoid paying more than your share of taxes.

BUSINESS OWNERS TAX STRATEGIES: QUALIFIED RETIREMENT PLANS

A qualified retirement plan meets the definition laid out in Section 401(a) of the tax code, allowing both business owners and employees to make pre-tax contributions, which then grow tax-deferred.  There are two basic types of qualified retirement plans: defined contribution and defined benefit plans.

Defined contribution plans, such as 401(k) plans, are more common.  Business owners benefit from tax strategies in two ways from such programs.  First, they can reduce taxable business income through employer contributions.  Second, they can reduce their personal taxable income by deferring part of their salary.

If you are over 50 years old, looking for ways to reduce taxable income and sock away a larger retirement nest egg, then a defined benefit plan may be your answer and can be an ideal solution for many business owners. 

Selling or transferring ownership of your business to new owners or family members can trigger a significant tax event.  One strategy that you can use to reduce a hefty capital gain tax on the sale is to freeze the value of your business. 

After you “lock-in” the business value, you will avoid capital gain taxes on any further increase in value.  Additionally, freezing the value can reduce or eliminate estate, gift, and generation-skipping taxes on any further value increase.  Freezing your business value can be a particularly effective tax mitigation strategy if you plan to transfer business ownership to children and grandchildren.

BUSINESS OWNERS TAX STRATEGIES: HIRE FAMILY MEMBERS

Hiring family members can yield significant tax benefits, particularly for small business owners under a sole proprietorship or single-member LLC.  For example, you can hire your spouse and provide all or most of their compensation in the form of a medical expense reimbursement plan.  This benefit is allowed in section 105 of the IRS tax code.

A section 105 plan allows for the tax-free reimbursement of healthcare and dental insurance premiums, along with out-of-pocket medical, dental, eye care, and other eligible medical expenses. Medical expense reimbursement plans can be significant tax savings for small business owners.

You can also hire your children to assist you in any number of ways. While they are minors, the salary you pay them is free from payroll taxes.  The salary is taxed at their minimal tax rate, and you can help them save the income for college.  

If your children attend college when they are 18 or older, they can claim themselves as dependents and receive tax credits up to $2500 annually.  Since this is a credit instead of a deduction, they can earn close to $40,000 annually free from federal taxes.  Compare that to the amount of taxes you would pay on the same $40,000, and you see how the tax savings of hiring your college-age children can add up.

CAPTIVE INSURANCE COMPANIES

Section 831(b) of the Internal Revenue Code allows business owners to set up their company as an insurance company as a wholly-owned subsidiary.  This captive insurance company ensures the risks of the parent company. 

The parent company funds the insurance operation tax-free.  The parent company also controls the premiums and claims, taking the commercial insurance company’s profit and the claims hassle out of the equation.  The investment income from the captive insurance operation is tax-exempt (not merely tax-deferred).

As a business owner, there are various types of captives for varying business needs. Still, most generally allow for tax-free funding of the insurance operation and tax-exempt income from the insurance operating profit. 

CHARITABLE TRUSTS

You can avoid capital gain taxes on the appreciated value of your business by first gifting the shares to a charitable trust before the sale.  Charitable trusts are powerful for business owners because it avoids capital gain taxes on the sale. 

It is best to use charitable trusts in combination with objectives other than tax reduction.  One example of this type of tax strategy is if you or a beneficiary you name can receive income distributions for life from the trust.  When you gift appreciated assets to a charitable trust, you also receive charitable tax deductions to help offset taxes on other income sources.

The Internal Revenue Code has hundreds of sections, many of which establish legitimate ways for business owners to avoid taxes and reduce the amount you pay to Uncle Sam over a lifetime.  Working with a tax-smart professional who understands your values, goals, and objectives can help guide you to the proper tax reduction strategies for you.

DISCLOSURE & ACKNOWLEDGEMENT

The information included in this material is for informational purposes only and should not be relied upon for any financial or legal purposes. Arlington Capital Management Inc, dba Arlington Wealth Management (AWM) is an investment adviser registered with the U.S. Securities and Exchange Commission.  Our registration with the SEC or with any state securities authority does not imply a certain level of skill or training, nor are we selling you any product.  Rather, we are seeking to provide you with advisory services.   Please consult with your own tax and legal advisers before investing. AWM cannot and does not guarantee the performance of any investment.  Past performance is no guarantee of future results.