With commercial real estate woes beginning to mount—whether it’s rent concessions, growing vacancies or a downturn in valuations—finding optimized investment and tax solutions for clients who want to sell their holding has become a pressing need for financial advisors.

Investment real estate is not an asset that is in many advisors’ wheelhouses. They know if they punt, however, they run the risk that clients may make potentially costly tax and investment mistakes, not to mention possibly consolidating all their assets with their newfound advisor.

Bill Howard, president of Howard Financial Solutions in Mooresville, N.C., never thought of punting when a longtime client came to see him with a healthy offer on an office building she'd owned for 30 years. The veteran CFP certificant and tax preparer knew there was a better approach than an outright sale.

“If she had sold outright at $800,000, she would have had a capital gain of $750,000 and only netted about $400,000 after taxes,” according to Howard, who said his client is in her mid-70s, has been running a clinical psychiatry practice in the building and was ready to retire.  

Howard also knew he could do a stand-alone 1031 transfer, which would allow her to defer taxes by simultaneously using proceeds from the sale to purchase another commercial property. But a new set of property management challenges and the reality of concentrating so much wealth in one property were unappealing solutions.

Instead, Howard began to study Delaware statutory trusts (DSTs).

“The more research I did, the more impressed I was,” said Howard, who chose a turnkey solution with Realized 1031, which offers a platform that lets investors exchange 1031-eligible properties, and rolled the client money into four different tax-advantaged DSTs, which provide all of the deferred tax advantages of a 1031 exchange. This option gave Howard the ability to build a portfolio of diversified geographic and property types with varying maturities, steady income and additional estate planning benefits.

The client now earns a cash distribution of 6%. “She received better cash flow and hopefully, over time, 1% to 2% appreciation in property prices. That’s very good and here’s something better: About 75% of the DST distributions are sheltered. Only 25% are taxable,” said Howard, who hung out his own shingle as an RIA rep with Durant Wealth Management Advisory.

Many baby boomers who hold highly appreciated real estate assets are at a stage where they want more passive, professionally managed ownership in commercial real estate. In 2004, the IRS issued a ruling allowing DSTs to structure trusts to qualify as replacement property for 1031 exchanges, while permitting DSTs to own 100% of the fee-simple interest in the underlying real estate. The ruling also allows up to 100 investors to participate as beneficial owners of the property. The investors may either deposit their 1031 exchange proceeds into the DST or purchase an interest in the DST directly. Some DSTs have investment minimums as low as $50,000.

DST investors stand to benefit from a professionally managed, institutional-quality property that small- to midsized accredited investors could not otherwise afford. The underlying property could be a 500-unit apartment building, a 100,000 square-foot medical office property or a shopping center leased to investment-grade tenants. However, by pooling money with other investors, they can acquire this type of asset.

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