How is a direct title security financed, and what financing counts as replacement debt?

The financing comes with the offering, not from a bank you apply to

Direct title securities are single-family rentals priced between $250,000 and $500,000, held in your own single-member LLC and triple-net leased. If you need leverage, we guide you through financing strategies that satisfy IRS requirements without dealing with traditional lenders, and the financing carries no personal liability.

That is a practical point for many exchangers. A retiring owner who would struggle to qualify for a conventional investment loan within 180 days can still put debt on a replacement property.

The terms are set per offering. Ask for the lender, the loan-to-value ratio, the rate and whether it is fixed, the term and amortization, prepayment terms, and any carve-outs from the non-recourse protection.

Debt on the replacement offsets the mortgage your sale paid off

The regulation treats "the amount of any liabilities of the taxpayer assumed by the other party to the exchange (or of any liabilities to which the property exchanged by the taxpayer is subject)" as money received. A mortgage paid from your sale proceeds is that kind of liability.

Reg. section 1.1031(b)-1(c) then nets it: liabilities you take on, or property you receive subject to a liability, are offset against liabilities you were relieved of. Cash you add from outside the exchange also offsets debt relief, as the replace the mortgage or add cash answer explains.

The debt has to be part of the purchase. A loan placed on the property at closing is consideration you gave in the exchange; a loan taken out later is a separate transaction and does not fix a shortfall.

Hypothetical: replacing a $240,000 mortgage across two houses

Round numbers, hypothetical. You sell a rental for $600,000, the closing pays off a $240,000 mortgage, and $360,000 goes to your intermediary. To defer everything you need at least $600,000 of purchases and at least $240,000 of new debt or added cash.

You buy two direct title properties at $300,000 each, each financed with a $120,000 loan, assuming the offerings' financing allows 40% loan-to-value. Exchange cash of $180,000 goes into each, the $240,000 of debt is replaced, and nothing is left over as boot.

Skip the financing and buy one $300,000 house all-cash, and $60,000 of cash is left over while $240,000 of debt relief goes unreplaced: up to $300,000 of your gain becomes taxable. Run your own numbers with your CPA.

Non-recourse protects your assets, not your tax position

Without personal liability, a default costs you the property and your equity, not other assets. The tax rules still count the loan. Under Commissioner v. Tufts, the outstanding nonrecourse balance is included in your amount realized when the property is sold or otherwise disposed of, and Reg. section 1.1001-2 applies the same rule to a foreclosure, so a lender taking the house can produce a taxable gain with no cash.

The interest is deductible against the rent, but principal is not; Publication 527 says you "can't simply deduct your mortgage or principal payments." Make sure the triple-net rent covers the debt service, because the lease is the property's only income.

Leverage also amplifies a fall in value. The DST leverage page explains the same risk for trust debt.

Once you own it, refinancing is your call

As sole owner you can decide to refinance for liquidity later, which a DST investor cannot. Tufts explains why the proceeds are not income: the borrower must repay them. Keep the refinance separate from the exchange in time and purpose; our refinance timing guide covers that line.

Publication 527 adds a limit: when you refinance for more than the old balance, "the portion of the interest allocable to loan proceeds not related to rental use generally can't be deducted as a rental expense."

• Get the payoff figure from your closing statement; that is your debt target.
• Ask each offering for its financing terms with the property details.
• Confirm the loan closes with the purchase, not after it.
• Check that the lease rent covers the debt service with room to spare.