A Delaware Statutory Trust (DST) is a legal entity with a co-ownership system. While the DST buys properties, investors or beneficiaries can contribute funding to receive a share of the trust. This system allows investors to take fractional interest on larger properties that they may not have been able to afford on their own. If you’re interested in DSTs, you should know about their requirements, how to use them and the dos and don’ts of DSTs.
Dos of DSTs
If you choose to invest in a DST, there are a few actions you’ll want to take when initiating the investment.
1. Conduct Due Diligence on the DST
Due diligence can enable you to make sound investment decisions regarding a DST. Delaware Statutory Trust investments will have a Private Placement Memorandum (PPM) that outlines the terms of the investment. PPMs describe the potential risks that come with investing in unregistered securities. They include information like a description of the property, sale terms, fees, associated risks with the property and more.
Reading the PPM closely will reveal cash flow expectations, who the sponsor is and what a DST’s objectives are. Understanding these details may help you decide if a DST property meets your investment goals.
2. Remember That DSTs Qualify for 1031 Exchanges
Many investors turn to 1031 exchanges for capital gains tax deferral. When you invest in a DST, you gain an ownership interest in the trust — the owner of the property. The IRS will treat this security as direct property ownership, so it will qualify for a 1031 exchange. All rules for a 1031 exchange still apply, including deadlines, like-kind property requirements and the equal or greater value rule.
3. Meet 1031 Exchange Debt Requirements With Your DST Debt Ratio
One of the notable Delaware Statutory Trust features is the debt ratio, and it’s vital to consider this if using a DST for a 1031 exchange. Some DSTs are all-cash and involve no debt, while others require every investor to receive a fraction of debt based on the mortgage taken on the property.
In these cases, all investors or beneficiaries receive a fraction of the cash, debt and expenses. A property will have a loan-to-value ratio based on the total value of the property and how much the DST mortgages. The investors do not have to personally qualify for this debt. The DST assigns it to them as an aspect of fractional ownership.
Say a DST acquires a property for $20 million and mortgages $9 million for a 45% loan-to-value ratio. Every investor will have a share of beneficial interest according to this ratio. If you invest $30,000, you’ll receive a debt assignment of about $24,500 for a total of $54,500 in beneficial interest.
To complete the exchange, this debt ratio needs to align with the equal or greater value rule in a 1031 exchange. This rule refers to the amount of exchange funds required to purchase the replacement property. Your exchange funds factor in the equity, debt and profits of your relinquished property, and your acquired property must cost this amount or more to qualify for a fully tax-deferred exchange.
4. Expect Loan Terms to Stay the Same
While it’s possible to refinance mortgages and loan terms on other properties, a DST is not permitted to refinance once it has acquired a property. Your loan-to-value ratio is locked in place once you become a beneficiary of the trust.
Don’ts of DSTs
After you’ve acquired shares of beneficial interest in a DST, here are the things you don’t do as a beneficiary.
1. Manage the Property
A team of professionals takes on the responsibilities of managing a DST asset, so you don’t have to. They handle the challenges of property management, from communicating with tenants to upkeep.
You may have been in charge of property management in other real estate investment scenarios. Some people may prefer this hands-on approach, but others want fewer responsibilities for real estate investments, which DSTs can provide.
2. Take on Liability for the Property
While you invest money in a DST, you are only a beneficiary, not an owner. A DST is the sole owner of the property, and they maintain the deeded title. Since you don’t claim ownership as an investor, you don’t claim liability either.
What does this mean for you? The management team for the DST will address any liabilities as they see fit. You are not liable for anything above the amount you invested. For example, a settlement from a tenant’s lawsuit cannot penetrate past the DST to your personal assets. Even if the property faces unexpected problems, you will not lose more capital than what you invested into the DST.
3. Qualify for Debt
Your other liabilities and personal assets will have no effect on your ability to invest in a DST. DSTs are the only party liable for mortgage loans, so you don’t have to qualify for debt. Instead, the DST will assign you a portion of the total debt based on the loan-to-value ratio.
The lack of debt qualification means you do not need to provide personal documentation for loan approval when investing in a DST. This scenario differs from a personal property investment where you have to personally qualify for a mortgage.
4. Miss Deadlines
If you intend to use your share in a DST for a 1031 exchange, be mindful of the deadline requirements. Investors have 45 days to identify an equal or greater property for the exchange and 180 days to close on the sale. If you miss these deadlines, your new DST will not qualify for the 1031 exchange.
5. Stress Yourself Out Looking for DSTs
Investing in DSTs may be right for your portfolio, but you’ll need to find a property. You can explore your options with local real estate professionals and online listings to find a property that fits your investment goals.
At 1031 Crowdfunding, we offer an extensive marketplace of DST properties to make it easier to meet your investment goals. You always have the option to look across multiple brokers and platforms, but we have the largest inventory of DSTs to simplify your search. 1031 Crowdfunding provides the property listings and expert guidance you may need.
Why It’s Important to Follow These DST Rules
Recognizing the risks and rules for investing in a DST can enable you to gain beneficial interest in a trust that aligns with your investment goals. If you choose to use a DST for a 1031 exchange, following all the rules will lead to the desired capital gains tax deferral without having to qualify for a loan.
Browse DST Properties at 1031 Crowdfunding
Investing in DSTs may be an option for you. Register at 1031 Crowdfunding today to access our DST properties marketplace. When you’re ready to invest in a property, our team can help you through the process.
This material does not constitute an offer to sell or a solicitation of an offer to buy any security. An offer can only be made by a prospectus that contains more complete information on risks, management fees and other expenses. This literature must be accompanied by, and read in conjunction with, a prospectus or private placement memorandum to fully understand the implications and risks of the offering of securities to which it relates. As with all investing, investing in private placements is speculative in nature and involves a degree of risk, including loss of your principal. Past performance is not necessarily indicative of future results and forward-looking statements and projections are not guaranteed to achieve the results described and your actual returns may vary significantly. Investments in private placements are illiquid in nature and there may be no secondary market or ability to sell the investment should the need for liquidity arise. This material should not be construed as tax advice and you should consult with your tax advisor as individual tax situations will vary. Securities offered through Capulent, LLC Member FINRA, SIPC.