Is it Possible to Claim Depreciation on a Delaware Statutory Trust (DST) Interest?
Investing in real estate involves more than just calculating income and expenses; it also entails considering the tax implications of the investment's value. For this reason, an investor may choose to invest in a Delaware Statutory Trust (DST) in order to potentially reap gains while enjoying the passive nature of ownership and income, as well as the tax advantages that come with it.
Understanding Depreciation in Investments
To gain a better understanding of depreciation, it's essential to comprehend its significance in real estate investment. Depreciation is a valuable tool for property investors as it allows them to recover the cost of an asset that is used to strive to generate rental income by taking an income tax deduction. Depreciation starts when a property is placed into service and lasts until it's disposed of, typically when it's sold.
To calculate depreciation, the first step is to determine the basis of the property, which is generally the purchase price minus the land value. Unlike buildings and other improvements, land doesn't lose its value, so it's not depreciable. After calculating the basis, the IRS assigns a specific recovery period to the depreciable asset based on its class, which is determined by the asset's use.
The Modified Accelerated Cost Recovery System (MACRS) is the tax depreciation system used by the IRS to calculate the allowable depreciation deductions for different classes of assets. For instance, residential real estate is typically depreciated over 27.5 years, while commercial properties have a depreciation period of 39 years. It's important to note that depreciation deductions can only be taken on the property's improvements, not the land, as the land is not subject to wear and tear and doesn't lose its value over time.
In summary, depreciation is a tax deduction that allows property investors to recover the cost of an asset used to strive to generate rental income. To calculate the depreciation, the basis of the property is determined by subtracting the land value from the purchase price, and then a specific recovery period is assigned to the asset based on its class. The MACRS is the tax depreciation system used to calculate the allowable deductions for different classes of assets. It's important to note that depreciation deductions can only be taken on the property's improvements, not the land.
Potential Advantages of Investing in a Delaware Statutory Trust (DST) for Investors
A DST, or Delaware Statutory Trust, can be an appealing option for investors who are interested in real estate investments but may not want the responsibility of direct ownership of commercial property. Additionally, investors may prefer the fractional option of larger assets that a DST can offer.
Under federal securities law, DSTs are classified as securities, but the IRS considers the investment to be direct ownership of real estate. This unique combination allows the taxpayer to use a 1031 exchange both to enter and exit the DST investment, providing investors with significant flexibility.
Investing in a DST can offer several benefits to a taxpayer who is seeking replacement property for a 1031 exchange. For example, if an investor needs to identify potential replacement properties but has a shortfall in value, they can easily fill any gap by adding a DST purchase to the mix. This flexibility can make it easier for investors to complete a successful 1031 exchange by replacing the total value of their relinquished property.
Alternatively, the DST investment can entirely replace direct ownership. Since the DST sponsor has already done the work of acquiring the property or properties, a potential investor can drastically reduce the risk of missing an IRS deadline and thus disqualifying their exchange. This is because the DST sponsor will manage the property, and the investor will not have the same level of responsibility that comes with direct ownership.
Additionally, DST investments can offer investors the potential for passive income and appreciation, as well as diversification of their real estate portfolio. The fractional ownership structure of DSTs allows investors to own a portion of larger assets that they may not have been able to afford on their own. This diversification can help mitigate risk and increase potential returns.
A DST can be an excellent option for investors who are seeking real estate investments but may not want the responsibility of direct ownership or prefer the fractional option of larger assets. With the ability to use a 1031 exchange to enter and exit the investment and the potential for passive income and appreciation, DSTs offer flexibility and potential for diversification in an investor's real estate portfolio.
While DSTs can offer benefits to real estate investors, it is important to keep in mind that they also come with risks. One significant risk is that investors must hold accredited status to participate in a DST, which means they must meet specific guidelines for assets, income, or expertise as established by the Securities and Exchange Commission (SEC).
Another important consideration is that DSTs are not liquid investments. Once an investor commits their funds to a DST, they should be aware that their funds are not readily accessible and are at risk, even though they may be receiving income distributions. Therefore, investors must carefully assess their financial situation and investment goals before choosing to invest in a DST.
The management of the DST is also a crucial factor that can impact the investment's success. Choosing the right fund sponsor is critical to ensuring that the property is well-managed and that the investment meets the expected returns. Investors should conduct thorough due diligence on the sponsor and their track record in managing real estate assets.
Overall, while DSTs can offer unique benefits, they are not without risks, and investors should carefully weigh the risks and rewards before deciding whether a DST is a suitable investment for them.
Not an offer to buy, nor a solicitation to sell securities. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing. Any information provided is for informational purposes only.
Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.1031 Risk Disclosure:
There’s no guarantee any strategy will be successful or achieve investment objectives;
All real estate investments have the potential to lose value during the life of the investments;
The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities;
All financed real estate investments have potential for foreclosure;
These 1031 exchanges are offered through private placement offerings and are illiquid securities. There is no secondary market for these investments.
If a property unexpectedly loses tenants or sustains substantial damage, there is potential for suspension of cash flow distributions;
Costs associated with the transaction may impact investors’ returns and may outweigh the tax benefits