Betty Friant CCIM is Executive Vice President, Managing Director, and expert DST 1031 advisor for Kay Properties & Investments.
If you own a business, especially one that includes real estate assets, understanding how to incorporate Delaware statutory trusts (DSTs) and/or qualified opportunity zones (QOZs) into your long-term planning can be a potentially powerful strategy when it comes time to implement an exit strategy.
For many successful real estate investors, having a detailed, long-term exit strategy is imperative to guiding them through market cycles and creating a blueprint for tax deferral options, wealth transfer and lifestyle changes. However, it is not uncommon for business entrepreneurs to be caught off-guard when they are faced with an unexpected offer to sell or decide that it might be time to retire.
Having a detailed plan for relinquishing a business’s real estate assets and the business itself can save entrepreneurs tens of thousands of dollars, open up opportunities for passive income and even propel their legacy into future generations.
How DSTs Can Potentially Work For Businesses With Real Estate Assets
Many businesses also include real estate assets as part of the company. For example, manufacturing businesses might include a warehouse structure and the land it is built on; agricultural enterprises often include multiple out-structures and land holdings.
For business owners who also own real estate assets associated with their business, understanding how a Delaware Statutory Trust works can serve as a great tax deferral tool by using it as a part of a 1031 exchange. This can help business owners not only defer capital gains taxes but also accomplish various investment objectives such as maximizing cash flow, enter into a more diverse real estate portfolio and reduce hands-on management responsibilities.
How QOZs Can Work Well for Entrepreneurs Selling A Business
But what about the actual business itself? Typically when a business is sold, the owners receive their profit from the transaction and simply pay the capital gains tax on the gains of the business. Unfortunately, the IRS and capital gains taxes can potentially eat up to 40% of the proceeds. However, with careful planning and one-on-one consultations with a tax attorney or CPA, entrepreneurs can take advantage of another effective tax-deferral strategy: the qualified opportunity zone.
Congress established QOZs in connection with the Jobs Act of 2017. It was specifically designed to promote long-term investments in low-income communities across the United States. These zones were designed to revitalize underserved regions of the country by channeling private capital while simultaneously providing tax benefits to investors.
Example Of How A Business Owner Can Utilize Both DST And QOZ
First Step: DST
Recently, I was able to guide a business owner through both a DST and QOZ in order to help accomplish specific objectives when it came time to sell real estate assets of the business and the business itself. The family had built a sizable manufacturing business that included multiple warehouse buildings. When they decided to sell both the business and the real estate associated with the business, they sat down with me and outlined specific investment objectives.
Once these goals were articulated, it was clear that regarding the real estate aspect of their business, the best way to accomplish all their objectives would be for the owners to relinquish their industrial real estate and invest in a Delaware Statutory Trust via 1031 Exchange.
Shortly after that, my team of DST experts spent much time working closely with the family to educate them on the benefits and potential risks associated with DST investments. This included identifying a variety of potential Delaware Statutory Trust properties that would accomplish their investment objectives.
Of course, this had to be completed within the specific timeframes of a 1031 exchange (investors need to identify their replacement property within 45 days and complete the exchange within 180 days). The result was a successful 1031 exchange and subsequent reinvestment into a portfolio of Delaware Statutory Trust real estate assets that created the potential for greater diversification through various locations, asset classes and even tenant mix.
Second Step: QOZ
After accomplishing the 1031 Exchange into a Delaware Statutory Trust, the client opted to sell the existing business entity in a distinct deal and utilize the profits to invest in a qualified opportunity zone (QOZ) as an extra tax deferral tactic.
An interesting point of note is that before these zones were created, business owners had no way to defer taxes on the sale and any potential gains of their business enterprise. But now, with QOZ investment options, entrepreneurs can reinvest the proceeds from the sale of their business as a tax-efficient strategy. Even nicer, if the investor holds the QOZ investment for 10 years or more, the IRS allows the investor to pay no federal capital gains taxes on any increase in value of the QOZ after the initial date of investment.
In this case, the business owner invested in a QOZ that included a large undeveloped parcel of land in the Knoxville, TN area. The QOZ will eventually be developed into a multifamily property with more than 300 apartment units, including approximately 40 that will be workforce housing for residents.
I like to point to this case as an example of how business owners who also own real estate associated with their business can not only reduce taxes but do something good for those who are less fortunate.
Overcoming Any Hurdles
While the benefits of DSTs and QOZs can be significant, investors should be aware of potential hurdles like the complexity of the regulations, the risk of investing in a property or business in an economically distressed area and the potential for unexpected tax consequences.
To overcome these hurdles, it is important to do thorough research, work with experienced professionals and carefully evaluate the risks and potential rewards of each investment opportunity. Some general best practices for preparing a business and property for these processes include maintaining good record-keeping practices and staying informed about changes to the regulations. By taking these steps, investors can make informed decisions and maximize the benefits of these investment structures.
Potential returns/appreciation not guaranteed & loss of principal is possible. Speak with your CPA/attorney for tax/legal advice.
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