Debt or No Debt? Evaluating DSTs and Tax Savings

Debt or No Debt? Evaluating DSTs and Tax Savings

At Corcapa 1031 Advisors, we often recommend Delaware Statutory Trusts (DSTs) for their tax deferral benefits under IRC Section 1031. A key feature of many DSTs is non-recourse debt, which may enhance after-tax income for investors. Here are some helpful insights:

What is Non-Recourse Debt?

Non-recourse debt is financing secured solely by the DST property, not your personal assets. If the trust defaults, lenders can seize the property but cannot pursue your other holdings—limiting your liability to your investment.

As financial advisors we tailor your 1031 exchange portfolio to match your risk tolerance, goals and objectives. We also strive to optimize tax deferral and after-tax income. A pivotal decision is to choose between Delaware Statutory Trusts (DSTs) with non-recourse debt or no debt—especially given the tax savings debt offers. Here’s how to evaluate:

DSTs with Non-Recourse Debt

Tax Savings: Debt enhances tax efficiency:

• Increased Depreciation: Assume an investor is selling a fully depreciated debt free property for $1million.  If that investor exchanged the full $1million into a Multifamily DST with nonrecourse debt at 50% Loan to Value, the investor would now own $2million of real estate. The additional $1million worth of real estate would be eligible for deprecation and cost segregation.  Depending on their specific situation, the investor may owe no taxes on the income generated by the DST during the 6-to-8-year anticipated hold period.  (This is not tax advice.  Corcpa is not a tax advisor.  We would be happy to refer you to a 1031 exchange specialized tax advisor for a consultation.)
• Interest Deductions: Interest payments on the loan may also be deductible, lowering the taxable income.

Risk: Debt can increase volatility if occupancy drops or values decrease.

Best For: Investors who either have existing debt that needs to be replaced or those looking to maximize their after-tax income.

DSTs with No Debt

Tax Profile: Investors may carry forward their remaining depreciable basis, but many 1031 exchange candidates have little remaining basis therefore most of the income from their replacement property portfolio would likely be taxable.

Risk: Less after-tax cash flow in your pocket.

Best For: Conservative investors who prioritize less volatility over tax savings.

Key Factors

• Risk tolerance: Debt amplifies gains and tax savings but adds risk.
• Income needs: Potentially higher after-tax income with leveraged DSTs.
• Tax goals: Leverage increases deductions.

Schedule Your Consultation

Corcapa 1031 Advisors works with you to ensure your DST choices align with your objectives. Contact us at (949) 722-1031 or schedule a consultation to discuss your specific goals.