What are Zero Cash Flow DSTs?

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A Potential Solution to Cover 1031 Exchange Debt Requirements

Zero cash flow properties (zeros) are investment structures that help investors meet the 1031 exchange requirements of spending all of the equity (proceeds) from the sale of the relinquished property on a replacement property, and assume a loan on the replacement property that is equal to or greater than the amount of debt on the loan from the relinquished property. Zeros are typically highly leveraged commercial real estate assets with long-term leases backed by investment-grade tenants. These property types have debt service obligations that are paid from the net operating income (NOI) generated by the properties, thus offering no cash flow to the investor. Investors looking to cover 1031 exchange replacement requirements might find a zero an attractive solution.

Hypothetical Example*

An investor is coming out of a moderately leveraged property sale with $400,000 equity left for reinvestment. To fulfill the debt requirement of the 1031 exchange and avoid tax implications, the sum of the cash invested and the debt placed on the replacement property must be equal to or greater than the sum of the cash invested and debt placed on the relinquished property. The investor chooses two replacement property investments, one with an average loan-to-value ratio (LTV), the second is a zero cash flow investment with a high LTV. Here’s how a zero would be utilized to meet this investor’s needs.

Sale of Relinquished Property
Total Sales Proceeds	$1,000,000
Mortgage Balance (Debt Remaining)	$600,000
Net Sale Proceeds (Equity Available for Reinvestment)	$400,000
Replacement Property Investments
Investment A
LTV	50.92%
Equity Invested	$350,000
Total Investment A Amount (Equity/1-LTV Percent) ($350,000/1-0.5092)	$713,121.43
Debt Assumed on Investment A ($713,121.43 – $350,000)	$363,121.00
Investment B (Zero)
LTV	83.60%
Equity Invested	$50,000
Total Investment B Amount (Equity/1-LTV Percent) ($50,000/1-0.8360)	$304,878.04
Debt Assumed on Investment B ($304,878.04 – $50,000)	$254,878.04
Total Investment Amount ($713,121.43 + $304,878.04)	$1,017,999.47
Debt Assumed on Total Investment ($363,121.00 + $254,878.04)	$617,999.04

This hypothetical example satisfies 1031 exchange requirements with the total equity invested being equal to or greater than the net sales proceeds from the relinquished property, and the Debt Assumed on the Total Investment being greater than the debt on the relinquished property.

*Note this is a simplified example intended to solely illustrate the way in which a zero cash flow property investment can satisfy the debt requirements of a 1031 exchange transaction and is not intended to provide a recommendation of investment or to provide tax advice.

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This article was published by Inland. You can download the original copy, here.

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