WHAT IS DRIVING THIS CHANGE FROM ACTIVE TO PASSIVE OWNERSHIP?
One cannot underestimate the motivating power of fatigue caused by maintenance hassles, legal liability, management burdens, regulatory compliance, and bookkeeping. Further, unlike institutionally managed properties, individual landlords do not have the resources to ensure ideal renter profiles.
This problem is exacerbated by West Coast rent-control rules that restrict landlords’ ability to manage tenant risk. Finally, the market values of many residential properties (particularly in California) have outpaced rental growth over the last 15 years, causing yields on equity to decline steadily.
COMMON BENEFITS OF 1031-QUALIFIED DSTS
For a number of beleaguered landlords, 1031-qualified DSTs offer the opportunity to escape the burdens of direct ownership and relocate their equity to properties where yields may be higher, economics may be brighter and local governments may be friendlier. In addition to the benefits described below, DSTs offer limited legal liability, flexible investment increments, escrow-free digital applications, and the potential for enhanced depreciation deductions. Tax Deferral or Avoidance A property structured as a DST allows hundreds of investors to acquire indirect beneficial interests in the underlying real estate. Owners receive a pro rata share of all net income and depreciation. Under IRS Revenue Ruling 2004-86, DSTs are designed to qualify as a “like kind” replacement for a tax-deferred sale of rental property. Unlike appreciated stocks 5 , which cannot be sold/replaced without recognizing a gain, passive real estate held for investment (including DSTs, TICs, mineral interests, etc.) can be exchanged multiple times over one’s life. Moreover, all deferred capital gains taxes and depreciation-recapture taxes potentially can be avoided altogether when the cost basis is “stepped up” at death. 6 The same familiar deadlines for 1031 exchanges (45 days for identification and 180 days to close) apply equally to DSTs. Truly Passive Ownership Investors in 1031-qualified DSTs no longer have the major hassles of being a landlord.
Challenges of being an active owner
Advertising for new tenants
Bookkeeping costs
Listing agreements
Applicant screening
Tax or insurance bills
Notice requirements
Lease negotiations
Late-night emergencies
Threats of litigation
Tenant improvements
Calls with tenants/managers
Late rent/damages
Property maintenance
Loan payments
Evictions
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