Investors desiring the tax deferral benefits of 1031 exchanges coupled with the advantages of fractional ownership are increasingly seeking the popular alternatives of Tenant-In-Common (“TIC”) or Delaware Statutory Trust (“DST”) co-ownership. Recently, DSTs have been gaining in popularity for a number of reasons including the ability to secure financing more easily and attract more investors with lower minimum investment threshold amounts.
Let’s look at some of the attributes of DST fractional ownership and how DSTs differ from TIC ownership.
What Is a DST?
A Delaware Statutory Trust is a separate legal entity created as a trust under the laws of Delaware in which each owner has a “beneficial interest” in the DST for Federal income tax purposes and is treated as owning an undivided fractional interest in the property. In 2004, the IRS released Revenue Ruling 2004-86 which allows the use of a DST to acquire real estate where the beneficial interests in the trust will be treated as direct interests in replacement property for purposes of IRC §1031. Due to the restrictions for DST qualification, the best attributes for a DST are generally single-tenant occupancy, an investment-grade tenant with a long-term lease to avoid turnover costs and triple net lease terms which require the tenant to pay all property expenses.
In order for a DST to quality for a 1031 exchange, the trustee may not have the power to do any of the following:
1. Accept contributions from either current or new investors after the offering is closed;
2. Renegotiate the terms of the existing loans, or borrow any new funds from a third party;
3. Sell real estate and use the proceeds to acquire new real estate;
4. Make other than minor repairs that are considered (a) normal repair and maintenance (b) minor non-structural improvements and (c) those required by law;
5. Invest cash held between the distribution dates other than in short-term government debt;
6. Retain cash, other than necessary reserves (all cash must be distributed on a current basis);
7. Enter into new leases or renegotiate the current lease.
A chief advantage of the DST structure is that the lender views the trust as only one borrower (rather than having up to 35 borrowers as in many TIC arrangements), which makes it easier and less expensive to obtain financing. In addition, since the investor’s only right with respect to the DST is to receive distributions and they have no voting authority regarding the operation of the property, the “bad boy carve outs” are eliminated and the lender looks only to the sponsors for these carve outs from the non-recourse provisions of a note.
Other differences between a DST structure and TIC structure are, but are not limited to:
|DST STRUCTURE||TIC STRUCTURE|
|IRS Guidance||Rev. Rul 2004-86||Rev. Proc. 2002-22|
|Maximum Number of Investors||No IRS imposed limitation||Up to 35|
|Ownership||Percentage of beneficial ownership in a DST that owns real property||Undivided tenant in common interest in real property|
|Investors Receive Property Deed||No||Yes|
|Investors Form Single Member LLC||No||Yes (generally)|
|Major Decision Approval||No voting rights||Equal voting rights and unanimous approval|
|Number of Borrowers||1 (the DST)||Up to 35 (the maximum number of investors)|
|Bankruptcy||Yes||No/Yes (if using a single member LLC|
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 in Delaware Statutory Trust (DST) properties including, but not limited to, the loss of the 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, all of whom are independent of Asset Preservation, Inc.
This article was provided courtesy of Asset Preservation, Inc. Asset Preservation, Inc. is a National Qualified Intermediary that can be reached at 1-800-282-1031. www.apiexchange.com
Please contact Fortitude Investment Group at www.1031dst.com or call 844-4DST1031 (844 437-8103) for more information.