Many investment property real estate buyers and sellers, whether they are some of the most prominent real estate investors in the country right down to mom and pop who took a chance on buying a multi-family investment property in NYC years ago, may now be faced with a big challenge on what to do now that they are getting dream offers of a lifetime on their properties.
First, they should talk to their real estate attorney or CPA to see what their tax liability will be if they decide to relinquish their property. Then, they should decide if they want to continue to be landlords and deal with the all too common toilets, tenants and trash. As long as they are accredited investors they should ask their attorney or CPA about a 1031 exchange utilizing a Delaware Statutory Trust (DST) to see if they are suitable.
1031 DSTs are securitized real estate programs that are 100% eligible to 1031 exchange into and are 100 passive investments to the investor. The DST may give the seller the ability to diversify out of a highly appreciated, single investment property into multiple sector classes—such as healthcare, multi-family, triple-net retail, or student housing— across the country. These properties are managed by some of the largest institutional real estate firms in the United States.
Months before you decide to sell your property it would make sense to look into the 1031 DST to see if it may be the right choice for you.
Potential Advantages of the DST
One of the major advantages to the DST is that they come in all shapes and sizes. Some are all cash and some can have as much as 70% LTV. The debt that is in place on the DST is non-recourse to the investor and the investor receives all the benefits of the debt on the property, if there is debt on the DST. Typically, a program will run anywhere from 7 to 10 years. DSTs may be a very important asset for a client selling a property who is looking for a full replacement, or even partial replacement, to complete their exchange.Key points regarding DSTs
In accordance with the Internal Revenue Service’s Revenue Ruling 2004-86, a beneficial interest in a Delaware statutory trust, or “DST,” that holds a replacement property may be considered “like-kind” replacement property in a Section 1031 exchange. A DST may own one or more properties. The rights and obligations of investors in a DST will be governed by the DST's trust agreement. Typically, investors have limited voting rights over the operation and ownership of any properties owned by the DST. In addition, the trustees of the DST may be entitled to certain fees and reimbursements, as set forth in the applicable trust agreement.
The Seven Deadly Sins: Internal Revenue Ruling 2004-86, which forms the income tax authority for structuring a Delaware Statutory Trust or DST transaction for use with a 1031 Exchange has prohibitions over the powers of the Trustee of the Delaware Statutory Trust of DST, which are known as the "seven deadly sins," and include the following:
1. Once the offering is closed, there can be no future equity contribution to the Delaware Statutory Trust or DST by either current or new co-investors or beneficiaries
2. The Trustee of the Delaware Statutory Trust or DST cannot renegotiate the terms of the existing loans, nor can it borrow any new funds from any other lender or party
3. The Trustee cannot reinvest the proceeds from the sale of its investment real estate
4. The Trustee is limited to making capital expenditures with respect to the property to those for a) normal repair and maintenance, (b) minor non-structural capital improvements, and (c) those required by law
5. Any liquid cash held in the Delaware Statutory Trust or DST between distribution dates can only be invested in short-term debt obligations
6. All cash, other than necessary reserves, must be distributed to the co-investors or beneficiaries on a current basis
7. The Trustee cannot enter into new leases or renegotiate the current leases
The Springing LLC
The Delaware Statutory Trust of DST agreement may contain a provision that provides that if the Trustee determines that the DST is in danger of losing the property due to its inability to act because of the prohibitions in the trust agreement (the seven deadly sins), it can convert the Delaware Statutory Trust or DST into a limited liability company (hereinafter referred to as the Springing LLC) with pre-existing agreed-upon terms.
The laws of the state of Delaware permit the conversion to a limited liability company through a simple filing with the office of the Secretary of State. The Springing LLC will contain the same bankruptcy remote provisions as the Delaware Statutory Trust of DST for the lender's benefit, but it will not contain the prohibitions against the raising of additional funds, the raising of new financing or the renegotiation or the terms of the existing debt or entering into new leases. In addition, it will provide that the Trustee will become the manager of the limited liability company.
Investors Seek the Potential Benefits of the Delaware Statutory Trust
Co-investors or beneficiaries looking for the tax benefits of a 1031 Exchange coupled with the advantages of co-ownership or fractional ownership in investment real estate are increasingly seeking the popular alternatives of Delaware Statutory Trusts or DST co-investor. Recently, the Delaware Statutory Trusts or DSTs have been gaining popularity for a number of reasons including the ability to secure financing more easily and attract more co-investors with lower minimum investment requirements. The Internal Revenue Service issued Revenue Ruling 2004-86 that sets out the guidelines for the Delaware Statutory Trust or DST. Delaware Statutory Trusts are trusts that are considered to be separate legal entities pursuant to the trust laws of the state of Delaware.
Each individual that co-invests in or through a Delaware Statutory trust or DST is a beneficiary of the Delaware Statutory Trust and therefore owns a "beneficial interest" in the DST for Federal income tax purposes. The co-investor or beneficiary is treated as owning an undivided fractional interest in the underlying investment real property.
One of the primary potential benefits of the Delaware Statutory Trust or DST Investment Property structure is the ease of obtaining financing compared to the Tenant-In-Common or TIC Investment Property structure. Lenders view the Delaware Statutory Trust as one borrower even though there can be up to 99 individual investors or beneficiaries.
DST 1031 properties are only available to accredited investors (generally described as having a net worth of over $1 million dollars exclusive of primary residence or $200,000 income individually/$300,000 jointly of the last three years) and accredited entities only. If you are unsure if you are an accredited investor and/or an accredited entity please verify with your CPA and Attorney. There are risks associated with investing in real estate and Delaware Statutory Trust (DST) properties including, but not limited to, loss of entire investment principal, declining market values, tenant vacancies and illiquidity. Diversification does not guarantee profits or guarantee protection against losses. Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated. The information herein has been prepared for educational purposes only and does not constitute an offer to purchase or sell securitized real estate investments. Because investors situations and objectives vary this information is not intended to indicate suitability for any particular investor. This material is not to be interpreted as tax or legal advice. Please speak with your own tax and legal advisors for advice/guidance regarding your particular situation. Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Advisory services offered through Concorde Asset Management, LLC (CAM), an SEC registered investment adviser. Insurance products offered through Concorde Insurance Agency, Inc. (CIA). Fortitude Investment Group is independent of CIS, CAM and CIA.