In the world of 1031 exchanges, it’s difficult to know where to begin. One option to consider is a Delaware Statutory Trust. Although not a new concept, current tax laws have made this type of investment an increasingly popular option that could be worth looking into for 1031 exchange investors.
Here is a breakdown of Delaware Statutory Trusts to help determine if they’re the best option for your situation.
What is a Delaware Statutory Trust?
Delaware Statutory Trusts, or DSTs, are a separate legal entity derived from Delaware Statutory Law. As a 1031 tax-deferred exchange, they let investors own a proportional interest along with the rights to distribution from the rental income or sale of the property.
Create a valuable inheritance to pass on
If you have intentions of creating a portfolio of income-generating investments that will outlive you and continue to provide for your heirs long after you’re gone, a DST could be a worthy investment candidate. As with all 1031 exchange-qualified investments, your heirs will receive a step-up in cost basis when they receive your DST assets so they will not have to inherit the previously deferred capital gain liabilities.
Gain opportunities for diversification
Because you can choose the amount you invest in a Delaware Statutory Trust, you can split your investment among multiple DST properties, giving you an opportunity to diversify your real estate portfolio.
Receive regular distributions
Delaware Statutory Trusts are permitted to keep a reasonable amount of cash reserves to be prepared in the event the property requires repairs or faces unexpected expenses. However, all earnings and proceeds above the reserve amounts must be distributed to the beneficiaries on a regular basis and within the expected timeframe.
Use as a 1031 exchange backup plan
1031 exchange investors can include a DST property among their three candidate properties identified during their identification period. If they cannot acquire their first two choices of identified candidate properties in time to meet their deadlines, the DST property remains an option that can close very quickly to meet the exchange deadline.
Lack of Control
With Delaware Statutory Trusts, investors can still enjoy the benefits of owning real estate without dealing with the day-to-day responsibilities of actively managing real estate. Although this may be a plus for some, others do not want to give up their management responsibilities. With a DST, investors do not have operational control or have the ability to make management decisions.
DSTs can be a longer-term investment, generally designed to last at least a couple years and can stretch as long as 10 in some instances. Due to DSTs being illiquid, some investors would prefer not to be locked in for this amount of time.
Inability to Raise New Capital
After the initial offer closes for the DST, no further contributions can be made by any investors. This means property maintenance can eat up a large chunk of profit and makes it highly important to have reserves set aside in advance.
Is it right for you?
Now that you have a better understanding of Delaware Statutory Trusts, it’s time to decide whether it’s the best type of investment for you to be making. Current tax laws have made DSTs a preferred investment vehicle for passive 1031 exchange investors. They are made up of multiple owners and ultimately controlled by the master tenant. DSTs provide a number of potential advantages to investors. They can be an effective tool for building and preserving wealth.
While the information provided above has been researched and is thought to be reasonable and accurate, it's important to understand that all investments, including real estate, are speculative in nature and involve substantial risk of loss. Additionally, private placements of securities are not publicly traded, are subject to holding period requirements, and are intended only for accredited investors who do not require a liquid investment.