The Delaware Statutory Trust as a Real Estate Investment
Delaware Statutory Trusts (DSTs ) have emerged as form of ownership as an alternative to Tenants in Common (TIC). Investors who hold highly appreciated real estate assets may be at a stage of their lives when they are seeking more passive investment opportunities. Passive, professionally managed ownership may allow them to concentrate on other opportunities in life that they have always been passionate and now have the time to pursue.
Passive Investment Characteristics
Rather than deal with the Terrible T’s consisting of toilets, trash, and tenants many long-time investors are in search of the Terrific T’s which give them time, travel, and teeing off.
To accomplish these goals, some seasoned investors have turned to real estate investment strategies such as buying real estate with ownership forms like, Tenants in Common (TIC) property or Delaware Statutory Trust (DST) property via an Internal Revenue Code (IRC) section 1031 exchange, thereby deferring tax on the relinquished property’s capital gain.
TIC 1031 and DST 1031 exchanges have long permitted investors to own institutional quality, professionally managed properties occupied by established tenants. They are offered on a turnkey basis with financing and management in place. Most investors have been able to accomplish these forms of ownership in a tax-deferred manner through a 1031 exchange.
Delaware Statutory Trusts
Though the Delaware Statutory Trust (DST) is not a new investment vehicle, inherent weakness in the structure of the TIC form of ownership discovered during the Financial Crises of 2008, has made the DST a viable investment vehicle for passive 1031 exchange investors as well as direct investors.
DSTs are derived from Delaware statutory law as a separate legal entity created as a trust, which qualifies under IRC section 1031 as a tax-deferred exchange. In 2004, the IRS blessed DSTs with an official Revenue Ruling about how to structure a DST that will qualify as replacement property for 1031 Exchanges.
The Revenue Ruling (Rev. Ruling 2004-86) permits the DST to own 100 percent of the fee-simple interest in the underlying real estate with no IRS imposed limitation as to the number of investors who may participate as beneficial owners with a fractional interest in the property.
Investors who are familiar with TIC investment strategies may see some similarities to the DST concept; however, it is important to understand the differences. While a TIC may have up to 35 investors, each owning an undivided, pro-rata share of title to the property, a DST may have many more investors, with each investor owning a beneficial interest in the trust which, in turn, owns the underlying asset. A major benefit is that more investors means lower investment requirements. DSTs are only available to accredited investors.*
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How DSTs Work
The real estate sponsor firm acquires the property under the DST umbrella and opens up the trust for potential investors to purchase a beneficial interest. The investors may either have their accommodator deposit their 1031 exchange proceeds into the DST or the investor may purchase an interest in the DST directly.
DST investors may benefit from a professionally managed, institutional quality property. The underlying property could be a 300-unit apartment building, a 50,000 square-foot medical office property or a shopping center leased to investment-grade tenants. The possibilities are numerous.
Most DST investments are assets that the average individual accredited investor, but for the opportunity to buy in to a fractional share, could not otherwise afford. However, by joining with other investors, they can acquire this type of asset.
DST vs TIC Ownership
There are two benefits that the DST structure offers over the TIC concept. One is that because a DST is not limited to 35 investors, the minimum investment may be much lower, often as low as $100,000. The second advantage is that in a DST the lender makes only one loan to one borrower, the DST Sponsor.
In a TIC investment there may be up to 35 separate signers to the loan. The DST gives the lenders greater security because the lender has fully qualified the sponsor, who is the underlying responsible party.
DSTs Pose Risks
DSTs are not without risks. As with any type of real estate investment, investors may be subject to high vacancy rates and loan defaults. DSTs are also not sole-ownership investments. A DST is a passive investment made up of multiple owners and ultimately controlled by the master tenant, the sponsor. It is important for investors who may be considering the DST strategy to consult with an experienced investment professional and to obtain competent legal advice and tax advice.
Upon thorough evaluation, the DST structure may be a viable investment alternative for qualified real estate investors. But only your tax adviser and lawyer can tell you if it’s right for you.
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*Accredited Investors are individuals whose net worth is more than $1 million and / or earn annual income of $200,000. Accreditation for entities means the entity’s assets are more than $5 million and / or each entity member must be an accredited investor as an individual.
IREXA Financial Services / Wealth Strategies provides Strategic Tax Planning to owners of real estate. We assist clients by planning for the future. Our goal: To help you keep more of what you make by only paying the taxes you are legally obligated to pay.
Robert L. Boggess, CCIM is the President/Chief Strategist with IREXA Financial Services / Wealth Strategies. Contact Bob at 206-548-1031, or rboggess@irexa.net.
IREXA® Financial Services / Wealth Strategies collaborates with CPAs, attorneys, and other tax planning professionals to assist clients with tax mitigation strategies. IREXA® and Great Point Capital, LLC are not tax professionals or attorneys. IREXA® only provides client tax mitigation strategies through, and with the approval of, the client’s professional counsel.
Securities offered through Great Point Capital, LLC, Member FINRA/SIPC, 200 W Jackson Blvd #1000, Chicago, IL 60606, telephone (312) 356-4872. IREXA® is not affiliated with Great Point Capital, LLC.
