In our experience, many clients who work a 9 to 5 job tend to leave the rental business to the spouse or partner with the most flexible schedule. Over time, one partner may envision retirement as leaving a job and “retiring” into the rental business while the other may want to retire out of the rental business.
Older individuals, who once performed all the maintenance on their rental properties, may find it physically impossible to keep up the pace of their younger years. The costs of hiring and out-sourcing maintenance reduces their monthly income at the very time in their lives that they may need it most.
Lastly with respect to spouses, couples may disagree on “what the children want.” One past client told us that he was going to leave all of his rentals to his son. His wife, active in their business, responded that their son didn’t want or need the rent houses. Interestingly, the son, a cardiothoracic surgeon living in another state had not yet been consulted. Leaving an inheritance of rental units can be good for some heirs, but a giant headache for others.
These are common reasons we’ve seen landlords seeking an answer to “how to retire.” They are not, however, every reason. Each landlord is in a different place. Some simply need to “downsize” (from 5 renthouses to 2), while others want to sell everything and upscale into a Delaware Statutory Trust (DST), when suitable. The attractiveness of more income potential is leading many to join the growing number of real estate investors who are moving from active to passive real estate.
Exit strategies are important for business owners, CEOs, investors and landlords. How to use tax laws and investment strategies to create income potential, save taxes and transfer wealth to the next generation is what we do professionally. DSTs are one tool, if suitable.
Delaware Statutory Trusts (DSTs) are growing in popularity as replacement property.6 The concept for business trusts dealing with property have been used since the 16th century, but it wasn’t until 1947 common law began to recognize statutory trusts in Delaware and 1947 legally recognized with additional federal recognition in 2004.
Concern: The rise in property values and rent payments have slowed to a crawl.
Possible Solution: A DST helps provide diversification of property type and geographical location. Examples include multi-family residential, office, retail, industrial, hospitality, assisted living, golf courses, self-storage, and even oil and gas producing wells. DSTs seek to provide a projected rising income to help mitigate inflation.
Concern: Taxes – capital gains, ACA7 tax and depreciation recapture.
Possible Solution: A DST is eligible for 1031 exchanges which defers taxes in the year in which the rental property is sold. Sometimes two properties are exchanged with cash leftover. This is called “boot” and it creates an unwanted taxable event. A DST is a popular solution to the “boot” problem. Additionally, a DST is a popular estate planning tool because re-registration can be inexpensive and DST’s help streamline the passing of real estate to heirs, who, in turn, receive a step-up in cost basis. This step-up can eliminate the inherited capital gains tax on that property.
Concern: Cash calls, Recourse loans, etc.
With DSTs, there are no “cash calls” for maintenance, insurance or taxes. New properties create a new depreciation schedule. So, the tax advantages of depreciation are “passed through” to the beneficiary owner reducing the taxable amount of each monthly potential rental income check. Seven restrictions8 of the DST protect the beneficiary owner from cash calls, recourse loans, many landlord liabilities, creates a delegation of management, eliminates franchise tax and provides the availability of indemnification.
7Affordable Care Act of 2010