Delaware Statutory Trust & 1031 Exchange
DST & DST 1031 Exchange Overview
A DST is a separate legal entity formed as a trust under Delaware law. If properly structured, the DST will be classified as a grantor trust for federal income tax purposes and, as a result, the purchaser of a beneficial interest in the trust will acquire an undivided interest in the asset(s) held by the DST. An investor can use a beneficial interest in a DST as replacement property in a 1031 tax deferred exchange. A DST is structured so that each beneficiary (investor) owns a beneficial interest in the trust. The managing Trustee of the DST is either the Sponsor or an affiliate of the Sponsor.
Benefits of A DST 1031 Exchange
• The DST is the single owner and borrower; the lender only underwrites the DST, not each individual investor therefore the loan is nonrecourse to the investor.
• The transfer of beneficial interests in a DST can be easier as there is generally less paperwork and time required than buying a property directly.
• A typical minimum investment of $100,000 allows more flexibility for investors to diversify their exchange into several properties compared to trying to purchase a property directly.
• The DST allows cash investors (non-1031) the option to complete a 1031 tax deferred exchange when the current property is sold.
• Investors are not required to sign on guarantees for non-recourse carve-outs on the loan that they might have with direct ownership.
Risks of a DST & DST 1031 Exchange
• No guarantee - There is no guarantee that any strategy will be successful or achieve investment objectives.
• Potential for property value loss – All real estate investments have the potential to lose value during the life of the investments.
• Change of tax status – The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.
• Potential for foreclosure – All financed real estate investments have potential for foreclosure.
• Lack of property management control - A DST owner does not maintain management control or dictate day-to-day property management operations.
• Illiquidity –These assets are commonly offered through private placement offerings and are illiquid securities. There is no secondary market for these investments.
• Reduction or Elimination of Monthly Cash Flow Distributions – Like any investment in real estate, if a property unexpectedly loses tenants or sustains substantial damage, there is potential for suspension of cash flow distributions.
• Impact of fees/expenses – Costs associated with the transaction may impact investor's returns and may outweigh the tax benefits.
• Stated tax benefits – Any stated tax benefits are not guaranteed and are subject to changes in the tax code. Speak to your tax professional prior to investing. Prospective investors should consult with a financial advisor, attorney and/or tax advisor regarding a DST 1031 exchange before selling a property.
Additional Reasons to Use a DST
• Relieve the burden of active real estate ownership
• Exchange a non-cash flow producing property for a cash flow producing property
• Obtain ownership in shopping centers, multi-residential and/or triple net lease property in good locations
• Diversify your real estate portfolio by geography and property type
• Facilitate estate planning
• Consolidate many properties into a single, more manageable parcel
Why Cash invest in DSTs
The potential benefits of a DST program are not restricted to 1031 exchange funds. Investors may also choose to invest directly into a DST which may provide the following potential benefits:
- Tax-deferral strategy
- Rental income paid monthly
- Ownership in institutional-quality real estate
- No management responsibilities/passive ownership
- Diversification of real estate portfolio
- Depreciation of real estate can help to offset taxable income