DSTs, TICs and U.S. Code § 1031 are three different tax rules that help real estate investors, landlords and developers defer capital gains taxes on the sale of rental properties.
These tax rules are designed to facilitate real estate transactions by reducing the amount of time it takes to sell properties, as well as reducing the amount of capital gains taxes investors have to pay.
The rules are theoretically simple, but the reality is that many investors don’t understand the implications of the rules or how to take advantage of them. This article is dedicated to explaining the differences between DSTs, TICs, and U.S. Code § 1031.
DSTs
A Dividend Reinvestment stock (DST) is a type of stock that is traded on an exchange, where investors buy and sell shares of real estate companies that pay dividends. The idea is that by purchasing DSTs, investors can reinvest dividends from these companies to buy more real estate, thus growing their wealth over time. DSTs were originally created for companies that own stocks of other companies. A real estate company that owns a lot of other companies that pay dividends may be a good investment, but there’s no way for the real estate company to pay dividends without going through the tedious process of filing a tax return and paying taxes on those dividends. Real estate companies that own other businesses are the best use of DSTs, but there are a few other use cases, including using them as a hedge against rising interest rates, as well as using them as a form of an income property.
TICs
A Tax Information Exchange (TIC) is a stock that is publicly traded. Investors buy TICs in the hopes that the cash dividends they receive will be reinvested and used to buy more real estate. The problem with this strategy is that real estate developers are the sole owners of TICs, which means that they can use the cash dividends to purchase more property. This is why real estate developers are not the most popular use of TICs.
U.S. Code § 1031
A U.S. Code § 1031 exchange is an agreement made between a real estate developer and an investor that states the investor will buy the developer’s properties at a discount. The investor then holds onto the properties and rents them out at the market rate. The key to a successful U.S. Code § 1031 exchange is that rental income is reinvested and not paid out to the investor. With rent collected from tenants, the investor uses U.S. Code § 1031 to defer taxes on the sale of their property.
What is a U.S. Code § 1031 exchange?
A U.S. Code § 1031 exchange is when an investor agrees to purchase a property from a real estate developer but then agrees to hold onto the property and not sell it for a certain amount of time. If the investor does this for a certain amount of time, they’re able to defer paying taxes on the sale of the property.
The Basics of a U.S. Code § 1031 Exclusion
A U.S. Code § 1031 exchange is an agreement where an investor agrees to purchase a property from a real estate developer, but then agrees to hold onto the property and not sell it for a certain amount of time. If the investor does this for a certain amount of time, they’re able to defer paying taxes on the sale of the property. With rent collected from tenants, the investor uses U.S. Code § 1031 to defer taxes on the sale of their property.
How to use U.S. Code § 1031 Exchanges to Defer Taxes
If an investor is planning to use a U.S. Code § 1031 exchange, the first thing they need to do is calculate how long they’re planning to hold onto the property. Once they have that information, they can begin searching for a property to purchase. The investor then begins their negotiations with the seller. When the deal is done, the investor has two options:
- Purchase the property and immediately begin holding onto it for the required amount of time.
- Purchase the property and immediately begin holding onto it for the required amount of time. Once this is done, the investor must begin searching for another property to purchase.
Risks with U.S. Code § 1031 Exchanges
There are risks associated with U.S. Code § 1031 exchanges. First, the value of the property may go down, which could cause the investor to lose money on the deal. Second, tenants may not pay rent on time, which could force the investor to pay late fees and lose money on the deal. Third, the property could be subject to an unfair taking lawsuit.
Final Words: Should You Use DSTs and TICs?
Both DSTs and TICs are wonderful ways to defer taxes on real estate profits. However, they’re not without risk. If you’re interested in using either of these strategies, you’ll have to do your research and decide which one is right for you.
You may want to start by looking into the benefits and risks of each one to better understand if it’s right for you. Once you’ve decided on a strategy, you’ll need to be even more diligent with your research and due diligence.