Splitting a 1031: Take Some Cash, Roll the Rest into a DST

Most landowners think a 1031 exchange is all or nothing. Roll everything into the replacement property or pay tax on the full sale. That’s not quite right.

You can split a 1031 exchange. Take some cash at closing, pay the tax on that portion, and roll the rest into a Delaware Statutory Trust on a tax-deferred basis. The IRS calls the cash portion “boot,” and a partial exchange is a perfectly normal structure when it fits the family’s situation.

1031 exchanges and Delaware Statutory Trusts available through private placements are highly speculative, illiquid securities and involve substantial risk, including the possible loss of all principal invested.

When a split exchange makes sense

Five reasons we see most often.

The family needs cash now. A medical situation, paying down personal debt, gifting to a child, building a cash reserve. Sometimes the timing of a land sale lines up with a real cash need that can’t wait. Taking partial cash at closing and rolling the rest is cleaner than borrowing against a DST later.

Pre-paying the tax bill while it’s manageable. Some families would rather clear half the deferred tax now and carry forward a smaller deferred liability than carry the full liability into the next decade. It’s a comfort level decision more than a math decision.

Estate alignment. A landowner heading into estate planning may want to put the bulk of the proceeds into a DST that heirs will inherit at a stepped-up basis, while taking enough cash now to fund a charitable gift, life insurance, or a planned distribution to a non-DST asset.

Right-sizing the DST allocation. DST offerings come in fixed minimum increments. Sometimes the available DST allocation doesn’t match the full sale amount, and taking the difference as cash is the cleanest way to make the math work.

Replacement property is smaller than the sale. If the replacement DST is structured for a smaller dollar amount than your sale, the difference becomes boot.

How the math works

Imagine you sell your land for $3 million. After paying off any debt on the property, you have $2.5 million in equity to deploy.

You decide to take $500,000 in cash and roll $2 million into a DST.

The $500,000 in cash is taxable boot. You pay capital gains tax (federal plus state, plus depreciation recapture if applicable) on that portion. Depending on your state and your basis, that might be in the range of 20 to 35 percent of the cash portion.

The $2 million rolled into the DST keeps its tax-deferred status. To keep the boot at the $500,000 you chose, the DST also has to cover the debt-replacement piece: your share of its non recourse debt, plus any cash you add, must be at least the $500,000 loan paid off at the sale.

You walk away with cash in hand and a DST interest generating potential monthly income on the rest.

The debt-replacement piece

This is where partial exchanges trip people up. Debt paid off at the sale is treated like cash you received unless it is replaced, even when you are taking some cash on purpose.

If you sold land that carried a $1 million recourse loan, and you’re rolling $2 million of equity into a DST, you need at least $1 million of debt on the replacement side, or the equivalent in additional cash on top of the rolled equity. Any shortfall is added to your boot.

DSTs come pre-packaged with non-recourse debt. If the trust carries enough leverage, your share of its loan can cover the debt-replacement requirement without a loan in your name. Your CPA and your advisor should walk through the math with you before closing.

Can I divide one 1031 exchange across multiple DSTs?

Yes. Splitting can also mean dividing the exchange itself, not just setting cash aside. Each DST interest is a separate replacement property, so one farm sale can be spread across several trusts. Spreading the money this way may defer the gain on all of it while you diversify by property type, sponsor and region. Complexity and restrictions within a 1031 exchange program may significantly impact desired tax deferral outcomes.

The identification rules in Treas. Reg. 1.1031(k)-1(c)(4) set the limits on your 45 day list:

• Three property rule. Identify up to three properties of any value.
• 200 percent rule. Identify any number of properties, as long as their combined fair market value is no more than 200 percent of what you sold.
• 95 percent rule. Identify any number of any value, but you must then acquire at least 95 percent of the total value you identified.

We cover how to build that list in the 45 day identification list for land sellers, and you can see the kinds of property DSTs hold in our tour of DST property types.

A few practical points come up every time:

• Minimums. Each DST sets its own minimum investment in its private placement memorandum. That sets how many trusts a given amount of money can realistically reach.
• Backups. DST offerings can fill up before you fund. Naming backups usually means using the 200 percent rule instead of the three property rule, so your qualified intermediary and CPA should confirm how each DST interest is valued for that test.
• Debt across the mix. Your share of each trust’s loan is added together. The total, plus any extra cash, must cover the debt paid off on the land you sold.
• Closing logistics. Each DST closes separately, with the intermediary wiring funds to each one. Every purchase must close within 180 days of the sale, or by your tax return due date, including extensions, if that comes sooner, under Section 1031(a)(3).

Hypothetical example. A family sells farmland for $4 million and pays off a $1 million loan at closing, leaving $3 million of equity with the intermediary. To fully defer, they need replacement property worth at least $4 million and at least $1 million of debt, or extra cash to cover any shortfall. They put $1 million into each of three DSTs:

	Equity invested	Trust leverage	Share of debt	Share of property value
DST A, net lease retail	$1,000,000	None	$0	$1,000,000
DST B, self storage	$1,000,000	20 percent	$250,000	$1,250,000
DST C, multifamily	$1,000,000	50 percent	$1,000,000	$2,000,000
Total	$3,000,000		$1,250,000	$4,250,000

Combined, the three interests carry $1,250,000 of debt and $4,250,000 of value, which covers the $1 million loan and the $4 million sale. DST A alone would have fallen short on both. Each trust’s distributions are separate, and potential monthly income from any of them is not guaranteed; distributions may be reduced or suspended. This example is illustrative only, is not a real client, and does not describe any actual offering.

More trusts means more diversification, but also more paperwork, more fees and more sponsors to watch. We weigh that tradeoff in the pros and cons of DSTs for landowners.

The CPA conversation matters

A split exchange has more moving parts than a full one. We always tell clients to get a pre-closing tax estimation from their CPA before the sale. The CPA can confirm:

• Your basis in the original property
• Your projected capital gain
• Your projected depreciation recapture
• Your state-level tax exposure
• The federal and state tax owed on the cash portion you’re taking

That number tells you whether the cash portion you’re planning is worth what you’ll pay. Sometimes a $500,000 cash take produces a $150,000 to $200,000 tax bill. Some families decide that’s worth it. Some decide to roll everything and revisit liquidity later.

When a split exchange does not fit

Two common situations where we’d push back.

The cash isn’t really needed. If the cash you’re planning to take is going to sit in a savings account because “it just feels safer,” the after-tax cash is usually less productive than the deferred amount working inside a DST. We’ll say that out loud.

The deferred tax is large and the family plans to hold to death. If the entire deferred amount would otherwise be eliminated through the heirs’ stepped-up basis, paying tax on a partial cash take now reduces what gets stepped up later.

The risks of a partial exchange

Same risks as any DST: illiquidity for the rolled portion, no guarantee on income or principal, market exposure on the underlying real estate. The cash portion is just cash, with whatever tax bill follows.

Is splitting a 1031 exchange a normal move?

Splitting a 1031 is a normal, IRS-recognized structure. Take what you need now. Defer what you can. Rebalance later if circumstances change.

The visit is how we figure out which split makes sense, or whether one fits at all. We advise. We are not a sponsor and do not issue these investments. When you’re ready, let’s have a visit.

1031 exchanges and Delaware Statutory Trusts available through private placements are highly speculative, illiquid securities and involve substantial risk, including the possible loss of all principal invested. Complexity and restrictions within a 1031 exchange program may significantly impact desired tax deferral outcomes. Potential monthly income from such investments is not guaranteed and distributions may be reduced or suspended. DST 1031 properties are only available to accredited investors and accredited entities. This material has been prepared for educational purposes only, is not to be interpreted as tax or legal advice, and does not constitute an offer to sell securitized real estate investments. Investors are advised to speak with their own tax and legal advisors regarding their particular situation. Securities offered through Arkadios Capital, LLC, Member FINRA / Member SIPC. Advisory Services through Arkadios Wealth. Iron Ridge and Arkadios do not share any ownership.