Richard, 58, and Barbara, 57, Matthews are real estate investors, owning a portfolio of three commercial properties, including a retail strip center and two multifamily buildings. While the assets generated consistent income, they required significant hands-on management: tenant issues, maintenance coordination, leasing, and compliance.
As they approached retirement, their priorities have been shifting, and they are looking for ways to reduce day-to-day responsibilities, preserve capital, create income, and finally avoid a large tax burden upon sale. Several years ago, they had brought on a manager for their multifamily property. It wasn’t too long before the Matthews found that the manager was good, but the level of care the properties required for their standards just was not happening. They had to reverse course and move back to an active management role. Outside management was not a direction that would work for their wants and expectations.
Here was the challenge for the Matthews: Selling the properties outright would trigger substantial capital gains taxes and depreciation recapture. Additionally, transitioning from active ownership to a passive income model without sacrificing returns has proved difficult.
The Matthews knew they needed a solution that could eliminate active management responsibilities, defer taxes, and provide stable, passive income.
The Solution: Delaware Statutory Trust (DST)
The Matthews chose to complete a 1031 exchange into a Delaware Statutory Trust (DST). A DST is a legal entity that allows multiple investors to own fractional interests in institutional-grade real estate. Professional asset managers handle all operational aspects, including property management, leasing, financing, and maintenance.
The Implementation: How They Did It
- The Matthews sold their properties and initiated a 1031 exchange using a qualified intermediary at the closings.
- Within the IRS timelines, they reinvested the proceeds into multiple DST offerings diversified across several asset classes, including multifamily housing, industrial properties, and medical office buildings.
- Each DST was managed by an experienced sponsor, removing all active duties from the Matthews.
Results
1. Elimination of Management Burden
The Matthews no longer handled tenant calls, repairs, or administrative tasks. The DST sponsor assumed full responsibility for operations.
2. Passive Income Stream
They continued receiving regular distributions, comparable to their prior net cash flow, but without active involvement.
3. Tax Deferral
By utilizing the 1031 exchange structure, the Matthews deferred capital gains taxes, preserving more of their investment capital.
4. Portfolio Diversification
Instead of three properties in one region, the Matthews gained exposure to multiple asset classes and geographic markets.
5. Estate Planning Benefits
DST interests can be structured to simplify estate transitions, potentially offering step-up in basis advantages for heirs.
Conclusion
The Matthews, by transitioning into a DST, found it an effective strategy to shift from active asset management to a passive investment approach. It allowed them to maintain income, defer taxes, and significantly reduce their operational responsibilities, aligning with their retirement goals.
