What you need to know about TICs and DSTs to avoid a failed exchange due to replacement property issues
1031 exchanges often fail due to issues related to acquiring the suitable replacement property. What if I can’t find the right replacement property for my 1031 exchange in time? Can my selections be changed if they fail to meet the 45-day deadline? Do I have the option of changing my identification? We often receive questions like this. TIC properties and Delaware Statutory Trusts can help protect against these risks by taking the necessary precautions. If you’re unfamiliar with TICs and DSTs, you can find an overview at the end of this article. It’s often difficult to find or acquire replacement property that causes exchanges to fail (about 15% of them do). You can avoid some of them by following these tips.
A Step-by-Step Guide for a Successful Exchange (the earlier in the process, the better): Clarify your investment objectives
- Identify the types of investments that will help you reach your goals.
- It is essential to establish general investment criteria (lease duration, tenants’ profiles, geographic restrictions, etc.)
- Identify specific investment properties.
- It is essential to conduct due diligence.
- Invest in properties as soon as possible
- Meet allotted deadlines
A MISTAKE: Not identifying more than one property by the 45th day Is there a reason for this?
It is not uncommon for exchangors to place too much trust in their primary selection. Finance issues, fickle sellers, boundary issues, or unexpected complications can put exchangors at risk paying the tax.
A 1031 exchange is like buying a house; exchangers search for a long time until they find it. If the 45-day period has not yet begun, this may work in the early stages of the process.
In 45 days, you can complete a project! There are times when changes are complex because of the short timeline.
There is a shortage of suitable options in a hot market
- Investment criteria that are too restrictive or unrealistic
- Without investment objectives and standards, a sale may take longer.
How can it be avoided?
You should always use all three selections using the three-property rule. Your hard-earned equity is not at risk if a “sure thing” falls through.
Identify your investment criteria and objectives early in the process. Get in touch with one of our 1031 advisors!
Start looking for a replacement property before your sale closes
It is better to identify as many as possible. Exchangors do not know they can change their identification selection until midnight on their 45th day.
TICs or DSTs can be used as backups! It is much better to acquire a passive monthly cashflow property than to pay unnecessary taxes. These properties are “off the shelf” with a simple acquisition process.
A MISTAKE HAS BEEN MADE: The identified property (or properties) are no longer available.
Why does it happen?
- Property changes identify properties that are not under contract.
- Examiners commonly underestimate how quickly 45 days go by, so they delay narrowing down their choices for too long.
What can be done to prevent it?
Get the contract under contract as soon as you find a solid option! Most exchangers are afraid to be this aggressive, but we recommend tying up legitimate opportunities before your ID period ends. If you have a contract on a property, you’re less likely to lose it.
TICs and DSTs make great backups! If there is still enough ownership interest, it is a reliable backup as long as the sponsor is notified. Exchangers can reserve a stake in many sponsors’ deals with certain conditions. It is much better to acquire a property that provides passive monthly cash flow, regardless of your investment objectives.
Identifying property after 180 days but failing to acquire it What causes this to happen?
Before the 45-day period expires, exchangers haven’t done enough due diligence on their selection. Due diligence may reveal something that makes the acquisition undesirable, such as a title dispute, boundary dispute, or environmental issue, even if the property is under contract during the 45 days.
Failure to obtain suitable financing may also prevent a post-identification property from closing.
How can this be avoided?
Get everything done as early as possible. You can avoid the pitfalls of not acquiring property within the allotted timeframes by following the suggestions already provided.
With leveraged TIC/DST properties already having the financing, even those needing debt replacement can take advantage of their “plug-and-play” capabilities.
It would help if you understood why TICs and DSTs are valuable tools for protecting against failed exchanges. An option that can bail taxpayers out of paying a significant tax liability when unforeseen obstacles prevent them from acquiring their primary selection can be a substantial relief in those situations.
Taxes on failed exchanges are the last thing anyone wants. Closing in the 45 days following the closing of the relinquished property is the best course of action since this eliminates the possibility of a failed exchange. If the replacement property is closed within 45 days, the IRS does not even require identification of the replacement property. It is possible to complete TIC/DST properties within a few days. Identifying a DST/TIC property is undoubtedly a good idea if you are nearing the end of the 45-day identification period without a suitable replacement property.
It is a fractional interest in real estate that is deeded and titled as a TIC (Tenant in Common). Most TIC properties require low minimum investments, which is why they are so popular.
As low as $50,000, they provide access to investment-grade real estate for exchange participants in smaller exchanges (up to $1M).
Net leases are typical for TIC properties, which have the advantage of shorter lease terms (often as fast as 10 to 15 years) and solid corporate tenants responsible for the property’s taxes, insurance, utilities, maintenance, and upkeep. There is very little active involvement on the part of investors, and the tenant guarantees the returns, so they are predictable. Each month, exchangors bank accounts are directly deposited with a consistent, steady income. Due to their inventory-like nature, TIC properties are available through sponsors like our sister company Realtynet Advisors.
Delaware Statutory Trusts or DSTs are trusts under Delaware law that own property, and in turn, each exchanger/investor owns a fractional interest. Exchangers can access the institutional-grade property through DSTs, similar to what they can with TICs. DSTs are primarily beneficial because they are entirely managed by the sponsor, making them passive investments for investors.
In addition, the trust can hold multiple properties, providing security through diversification. The acquisition of DSTs through sponsors is also straightforward and quick, just like the acquisition of TIC properties. Exchanges with debt-replacement requirements can satisfy their debt needs by acquiring their pro rata share of the debt without the hassle of procuring their financing using DSTs with built-in funding. For on-demand exchanges, this is another excellent solution.
Other primary benefits of trusts include holding multiple properties in one and maximizing security through diversification. Like TIC properties, DSTs can also be acquired through sponsors.
Wherever you are in your 1031 process, our advisors are here to help – no spam and no strings attached.