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Analyzing the DST-to-721 Strategy with David Waal

As the DST-to-721 upREIT strategy continues to gain traction, financial advisors and large real estate sponsors are increasingly leveraging it as a solution for clients. However, David Waal of Irvine Advisors, LLC, insists that CPAs and real estate owners must take a closer look at its implications, emphasizing that a standard approach may not meet every client's needs.

Understanding the DST-to-721 Mechanism

The DST-to-721 strategy operates in two distinct steps:
1. 1031 Exchange into a Delaware Statutory Trust (DST): Initially, an investor utilizes a 1031 exchange to place their capital into a Delaware Statutory Trust. This move helps defer taxes on capital gains.
2. IRS Section 721 Exchange into a Real Estate Investment Trust (REIT): After a conventional holding period of approximately two years, the interests held in the DST are converted to shares in a REIT via an IRS Section 721 exchange.

While this structure can offer simplification and potential liquidity, it carries substantial long-term implications that must be critically assessed.

Key Considerations for CPAs

Waal highlights several crucial aspects for accountants and tax professionals:

• - Loss of Future 1031 Exchange Opportunities: Once a client opts for a 721 exchange, their ability to utilize future 1031 exchanges is permanently forfeited. This can limit their flexibility and planning options.
• - Liquidity through REIT Shares: Transitioning to a REIT brings liquidity, assisting in estate equalization among heirs, but it can also come with new liabilities.
• - Increased Fees: The fee structure generally elevates during the transition into a REIT, which may affect overall returns.
• - Narrowing Tax-deferral Options: The switch to a REIT could limit future tax-deferral pathways, conflicting with the client's long-term strategies and goals.

Motivation Behind the Promotion of the DST-to-721 Strategy

According to Waal, the uptick in recommendations for this strategy is less about investor demand and more about the machinery of Wall Street’s distribution channels. Large REIT sponsors have developed effective methods for raising capital and have pinpointed 1031 exchangers as a significant source of investment funds.

By collaborating with advisors who often lack extensive experience in real estate investments, these sponsors create a streamlined solution that directs clients to their REITs, sometimes without considering if the structure aligns with the investor's long-term goals.

When is the DST-to-721 Strategy Beneficial?

While Waal acknowledges the potential pitfalls, he notes that the DST-to-721 strategy isn't inherently flawed.

• - For clients who do not expect to pursue further 1031 exchanges—due to age or personal preferences—converting into REIT shares may provide a sensible estate-planning method. The liquidity of these shares simplifies asset division among beneficiaries.

The Case for a DST-Only Approach

Conversely, for investors keen on continuing to exchange properties, a traditional DST-only approach may offer enhanced flexibility. With DSTs typically retaining properties for five to ten years, investors can leverage potential cash flow while awaiting property appreciation. Upon exit, they retain eligibility for another 1031 exchange, which could be redirected into a selected investment property.

Waal critically reminds investors, especially those interested in utilizing properties like vacation rentals, to carefully consider the implications of committing to a 721 conversion.

A Holistic, Planning-Driven Approach

Irvine Advisors positions itself as an advocate for its clients navigating the complexities of a sales-centric investment landscape.

• - “Our mission is to provide comprehensive insights that aid clients and their CPAs in understanding the broader picture,” Waal explains.

Ultimately, determining the right investment strategy should be based on individual client circumstances—taking into account timelines, liquidity needs, tax implications, and legacy ambitions—rather than defaulting to a singular solution that may not be suitable for all. For more insights on DSTs, 721 exchanges, and strategic real estate planning, please visit www.davidwaal.com.