Improving Debt and Equity Planning through a 1033 Exchange

By Johannes Ernharth

Transitional Real Estate Wealth Specialist

Few investors would choose a 1033 Exchange willingly. But for those ready to shed debt and operational burdens, it can open the door to significant planning opportunities

Debt Planning with Delaware Statutory Trusts in 1033 Exchanges

Navigating debt obligations in a 1033 Exchange can seem complex, but understanding the key principles can help you turn a challenging situation into an opportunity. By learning how debt is treated on both the destroyed or condemned property and its replacement, you can make more informed decisions and improve your planning outcomes.  For the right situations, Delaware Statutory Trusts (DSTs) can be an important tool towards optimizing an investor’s balance sheet!

UNDERSTANDING 1033 EXCHANGE DEBT REQUIREMENTS

Lost Property

When real estate is destroyed or condemned from natural disasters, insurance or settlement proceeds will be reduced by any outstanding loans or mortgages that must be paid off. However, for full tax deferral under a 1033 Exchange, the replacement property must match or exceed the gross settlement amount paid —not just the net proceeds remaining after the debt is settled. A shortfall in replacement value will result in a taxable event.

To address this, investors may need to take on new debt or contribute additional cash. However, passive real estate investments, such as Delaware Statutory Trusts (DSTs), offer a practical and tax-efficient solution in these scenarios.

Replacement Property

One key advantage of 1033 Exchanges over 1031 Exchanges is flexibility on using debt rather than payments to satisfy replacement value obligations. Unlike 1031 Exchanges, which require all net sales proceeds to be reinvested into replacement property, 1033 Exchanges don’t care how your achieve the required replacement value. In other words, the “equal or greater value” obligation may be met using credit rather than settlement payments to acquire the property.

That means you can use the remaining settlement proceeds for other purposes, creating additional financial opportunities while still deferring taxes.

IMPROVED PLANNING

With those principles under our belt, let’s consider the prospective benefits of using DSTs to streamline debt planning through 1033  Exchanges to take full advantages of potential planning flexibility.

Satisfying Exchange Debt Obligations with DSTs

DSTs can satisfy exchange-debt requirements. When DSTs utilize leverage, investors are credited for their proportional share of the DST's debt. For example, a $500,000 investment into DST with a 50% Loan to Value (LTV) would be credited with $500,000 debt, for a total 1033 exchange amount of $1 million. This helps satisfy tax requirements without the need for out-of-pocket cash contributions or shopping for loans in difficult credit climates.

Non-Recourse Debt

A major benefit of DSTs is their debt is non-recourse to investors, shielding them from personal liability and responsibility. This can be especially attractive for older investors seeking to reduce or eliminate debt obligations. It also provides the alternative for Exchangers to rework balance sheet liabilities by leveraging the balance sheet of DST Sponsor.

Use DST Leverage for Tax-Free Settlement Cash

Given replacement property can be acquired using debt rather than cash from settlement payments, leveraged DSTs can free up cash for unrelated purposes.

For example, an owner receiving a $1 million net cash payment for a property destroyed in natural disaster is required to replace property worth $ 1 million or greater to achieve a full deferral.  The investor could use $500,000 of that payment to acquire a DST with a 50% LTV and be credited for $500,000 of property loan, for a combined total of $1 million replacement property value. That would satisfy the 1033 full deferral requirement.  The $500,000 left over from the $1 million payment received is free for other uses. 

Certain DST leverage can be 70% LTV or higher, providing creative options for freeing settlement cash for other uses.

Non-Recourse Debt for Added Protection

A major benefit of DSTs is their debt is non-recourse to investors, shielding them from personal liability and responsibility. This simultaneously allows Exchangers to adjust their balance sheet obligations by  the balance sheet of DST Sponsor.

Additional Benefits of Passive Real Estate in 1033 Exchanges

Passive real estate investments like DSTs offer numerous other planning advantages for 1033 Exchanges, including the potential for diversification, professional underwriting and management, and access to institutional-grade real estate typically out or reach of ordinary investors. Exploring these options with an experienced advisor can help you maximize your planning outcomes and turn a challenging situation into a strategic opportunity.

How RCX Supports 1033 Exchanges

At RCX, we specialize in guiding advisors and their clients through complex real estate wealth transitions, including 1033 Exchanges.

Our team brings extensive expertise in evaluating real estate transactions, analyzing property investment strategies, and advising on investment sponsor opportunities. We provide comprehensive due diligence and consulting services to ensure every step of the process is seamless and informed.

For advisors, we offer insights into the mechanics of Delaware Statutory Trusts (DSTs) and Tenants-in-Common (TICs) structures. Our tailored solutions align with your client’s unique goals, enabling you to integrate these strategies into both current and long-term plans.

To streamline the transition to passive real estate ownership, RCX offers pre-vetted DST and TIC opportunities that have undergone rigorous due diligence. These options are designed to align with the objectives you’ve established for your clients, making the transition efficient and effective.

For a deeper understanding of 1033 Exchanges, download our comprehensive guide here: