If you sell an investment property like a rental home or other piece of commercial real estate, you will owe taxes on the gain. Between capital gains tax and depreciation recapture, a taxpayer could pay more than 1/3 of their gain in taxes.
Many investors turn to DST programs to complete a tax-deferred exchange (known as a 1031 exchange). DST programs offer several advantages over finding individual replacement properties.
Some DST programs have an additional feature known as an UPREIT option. In these, an investor may have their DST interests subsequently acquired by a REIT on a tax-deferred basis, in exchange for Operating Partnership units (OP units).
This UPREIT option can provide additional benefits, such as:
- Further diversification: A DST may own a handful of properties, while a REIT may own hundreds
- Increased income: OP units often have a higher yield than DST interests
- No need for future exchanges: An UPREIT transaction ends the ability to complete future 1031 exchanges, but maintains the investor’s tax-deferred status indefinitely (subject to some limitations).
- Ability to control the timing of taxes: Deferred tax is not due until OP units are redeemed. An investor can choose if and when to request a redemption.
- Liquidity for heirs: Heirs can choose to redeem OP units at stepped up basis. DST interests do not usually provide liquidity to heirs until the properties in the DST are sold.
The 1031 exchange rules are complex. It is advisable to speak with a tax professional and a financial advisor well before an investment property is sold.
