Springing LLC in DSTs | The Emergency Safety Mechanism for 1031 Investors (Episode 4)

Hello and welcome to Exchange Insights, your resource for 1031 market intelligence and education. My name is Tom Wall, partner here at Anchor1031. This is the fourth and final episode in our DST structure series. Today we're going to cover the springing LLC, a safety mechanism that most DSTs have built into their structure.

So, what is a springing LLC? A springing LLC is a dormant limited liability company that's created at the inception of the DST offering but isn't activated unless certain triggering events occur. Think of it as a "break glass in case of emergency" provision. If something goes wrong with the DST, the springing LLC can be activated to take over ownership of the property. When activated, the DST transfers the property to the LLC, and investors exchange their DST interests for membership interests in the LLC.

So, why would a springing LLC need to be activated? The typical triggering events involve violations of the seven deadly sins or distressed property situations.

For example, if a lender threatens foreclosure and the only way to save the property is to refinance, the DST cannot refinance on its own. The springing LLC can be activated, the property transferred, and the LLC can then negotiate with the lender.

Other scenarios might include needing to make major capital improvements, signing new leases, or injecting fresh capital into the property. These are all things the DST cannot do, but an LLC can.

The springing LLC essentially provides an escape valve for situations where strict DST compliance would lead to worse outcomes for investors.

Now, here's the important part: activating the springing LLC has potential tax implications.

One of the benefits of a DST is that it qualifies as like-kind property for 1031 exchange purposes. When a springing LLC is activated, the tax treatment becomes less clear. There's an IRS gray area about whether the conversion from DST to LLC is a taxable event. Investors should consult with their CPAs before and after any springing LLC activation to understand the potential tax consequences.

So, how should investors think about the springing LLC?

First, understand that it's there for your protection. The springing LLC gives the sponsor flexibility to take action in emergency situations that could otherwise result in property loss.

Second, know that it's rarely used. In most cases, DSTs operate normally, the property performs as expected, and the springing LLC is never activated. But it's good to know it's there.

Third, ask questions about the triggering events. Different DST offerings may have different provisions. Understand what would trigger an activation and what that would mean for your investment.

Fourth, be aware of the tax implications. If the springing LLC is activated, work with your tax advisor to understand whether it creates a taxable event and how to plan accordingly.

In summary, the springing LLC is a safety mechanism that provides flexibility in distressed situations. It's an important feature that investors should understand but hopefully never need to use.

That wraps up our DST structure series. We've covered the seven deadly sins, the master tenant lease, and the springing LLC. I hope these videos have given you a deeper understanding of how DSTs are structured and what to look for when evaluating these investments.

Thanks for watching. If you'd like to learn more about DSTs or schedule a consultation, please visit anchor1031.com.