The COVID-19 pandemic has real estate investors questioning their portfolios' makeup, their interests in managing properties, and their long-term objectives. Delaware Statutory Trusts (DSTs), in which investors own shares in a trust rather than full properties, may contain some of the answers.
DSTs are passive real estate investments run by professionals who manage property acquisitions and day-to-day operations. They often contain relatively low minimums, making them accessible to many real estate investors.
The History Behind DSTs
The state of Delaware originated DSTs with the Delaware Statutory Trust Act of 1998. DST trustees and investors do not need to reside in Delaware, but they will file a trust certificate with the state when forming a DST.
Once a little-known trust structure, DSTs gained broader appeal with a 2004 Internal Revenue Service ruling. The IRS said, “A taxpayer may exchange real property for an interest in the Delaware statutory trust described above without recognition of gain or loss under § 1031 if the other requirements of § 1031 are satisfied.”
The IRS essentially made it possible for passive investors to own fractional shares in a real estate trust and opened the door for DSTs to be included in 1031 exchanges.
A DST in a 1031 Exchange
A 1031 exchange makes it possible to sell one real estate investment and reinvest the proceeds in a like-kind investment of equal or greater value to defer capital gains and depreciation taxes.
While some investors will relinquish one property and choose a single replacement property, the opportunity to invest in a DST gives investors an important tool to diversify holdings, have an interest in large-scale institutional holdings that may otherwise be too expensive, and serve as a backup replacement property if originally identified properties fall through.
Key Benefits of including DSTs in a 1031 Exchange
DSTs can have investment minimums as low as $25,000 and can be combined with other properties in a 1031 exchange. Investors aren’t required to qualify for property loans or establish and maintain a limited liability company (LLC), an expense that can run $1,000 annually, opening the door for investors to have a stake in multi-unit apartment complexes, commercial office buildings, and other property types.
1031 exchanges require like-kind replacement properties to be identified within 45 days of closing on the relinquished property and close on the replacement properties within 180 days. It’s possible to identify and complete a DST investment in less than five days, making it an ideal backup plan in a 1031 exchange for those up against deadlines.
Professional Property Management
Investors don’t need to be up against a deadline to find DSTs appealing.
For many investors, the biggest DST benefit is professional management. A property manager receives the call when a pipe bursts and figures out how to collect when a tenant is late with the rent. While those owning properties outright can always outsource maintenance and management responsibilities, the owner is ultimately the responsible party.
Most DSTs are set up for investors to collect regular distributions for a steady monthly income and look to capitalize on the appreciation of assets at the time of eventual sale.
Points to Consider Before Investing in a DST
While DSTs offer various benefits, real estate investors should be sure to read the offering memorandum’s fine print.
DSTs are long-term, illiquid investments that often are set up to last five-to-10 years. DST shares do not trade on an exchange, and if an investor wishes to exit before the trust goes full cycle, they will either need to find other investors to purchase the shares or sell them on a secondary market.
Some fees are not part of an actively management property, including commissions paid to leasing agents, property management costs, and the trustee's fees at the time of sale.
All 1031 exchanges require a Qualified Intermediary (QI) to facilitate the exchange and ensure the investor doesn’t take possession of the relinquished property’s proceeds. The QI may charge approximately $1,000 or more, but an experienced QI can help find DSTs that align with the investor’s goals and help the process go smoothly.
For more insight and details about how a DST may fit within your investment portfolio, download our latest Ebook, The ABCs of DSTs.
There are material risks associated with investing in DST properties and real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal. Past performance is not a guarantee of future results. Potential cash flow, returns and appreciation are not guaranteed. IRC Section 1031 is a complex tax concept; consult your legal or tax professional regarding the specifics of your particular situation. This is not a solicitation or an offer to sell any securities. DST 1031 properties are only available to accredited investors (typically have a $1 million net worth excluding 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.