What is a Delaware Statutory Trust?
A Delaware Statutory Trust (DST) is a separate legal entity created as a trust under Delaware statutory law, which permits a very flexible approach to the design and operation of the entity. Investors in a Delaware Statutory Trust own a pro rata interest in the trust and have the right to receive distributions from the operation of the trust, either from rental income, or from the eventual sale of the property.Learn more about Delaware Statutory Trusts
What is a Delaware Statutory Trust?
A Delaware Statutory Trust (DST) is a separate legal entity created as a trust under Delaware statutory law, which permits a very flexible approach to the design and operation of the entity. Investors in a Delaware Statutory Trust own a pro rata interest in the trust and have the right to receive distributions from the operation of the trust, either from rental income, or from the eventual sale of the property. Distributions are not guaranteed. They do not have deeded title to the property. It is the trust itself who has deed to the property and who, through the signatory trustee, makes the decisions regarding the disposition of the property including its eventual sale. The beneficiaries of the trust have no authority over the day to day handling of the property or the timing and details of its eventual sale. While initially this may seem to be disadvantageous to the investor, this structure actually opens up the possibility for significant advantages (Benefits of a Delaware Statutory Trust).
For the purposes of a 1031 tax-deferred exchange, the purchase of a beneficial interest in a DST is treated as a direct interest in real estate, thus satisfying that requirement of IRS Revenue Ruling 2004-86. (An IRS Revenue Ruling, unlike an IRS Revenue Procedure, may be relied upon by other taxpayers in defense of a 1031 exchange position).
A DST can also be an attractive investment vehicle for investors who are not conducting a 1031 exchange. All the benefits of securitized real estate as well as the financial specifics of the particular Delaware Statutory Trust remain, and in addition, because it is a direct interest in real estate for tax purposes, the investor can conduct a 1031 tax deferred exchange if and when the property is sold, thus beginning the cycle of tax deferred real estate ownership.
A Delaware Statutory Trust is in the nature of a unit investment trust or a fixed investment trust. In such a trust, assets, securities, real estate, etc. are purchased for the trust and held until such a time as the proceeds are distributed to the investors. The trust is not considered a taxable entity and, therefore, all the profits, losses, etc. are passed through directly to the investors.
The concept for business trusts, especially those that involve the holding of property, dates back as early as 16th century English Common Law. But until the passage of the Delaware Statutory Trust Act in 1988, no legal recognition of statutory trusts existed (12 Del. C. 3801 et. Seq.,). Under the act, developed on the premise of trust law, statutory trusts were now recognized as their own legal entity, separate from their trustee(s), offering freedom from the corporate law template. Within the tradition of trust law, freedom of contract allows the trustee(s) to structure their entity in a way that is most beneficial to the relationship of all parties and their expertise, while offering liability protection similar to that of a limited liability company or partnership.
Since the year 2000, Delaware statutory trusts have increasingly been used as a form of tax deferral, asset protection, and balance sheet advantages in real estate, securitization, and mezzanine financing. Finally, for the purposes of owning a "direct interest in real estate," which is critical to qualify for a 1031 exchange, IRS Revenue Ruling 2004-86 opened the way for DSTs to become the most common ownership structure used by smaller investors to own investment-grade real estate together with other investors. This revenue ruling states that a beneficial interest in a DST which owned real estate would be considered a "direct interest in real estate" and thus qualify for 1031 exchange, assuming of course that all the other requirements are satisfied.
With the additional problems for TIC ownership structures seen during the Great Recession, this trend only strengthened. Today about 90% of the securitized real estate offerings issued by 1031CrowdFunding for 1031 exchanges are DSTs.
Benefits of a Delaware Statutory Trust
For the purposes of a tax-deferred 1031 exchange, the purchase of a beneficial interest in a Delaware Statutory Trust is treated as a direct interest in real estate, thus satisfying that requirement of IRS Revenue Ruling 2004-86. A DST can also be an attractive investment vehicle for investors who are not conducting a 1031 exchange. In addition to all the benefits of securitized real estate, investors purchasing an interest in a DST enjoy the following additional benefits:
Perhaps the most significant advantage of Delaware Statutory Trusts is that the unanimous approval of the individual owners (investors) is not required in order to deal with unexpected, adverse developments. During the recent recession, which of course significantly affected the real estate market, some TIC structures were hindered from taking the necessary actions to mitigate loss, simply because one of the owners, a so-called "rogue investor," did not approve of the action desired by the majority. So while DST offerings are selected and structured to lessen the risk from such possibilities, all risk cannot be removed, and it is an additional protection to the investors that the signatory trustee is empowered to take necessary actions (restructure financing, renegotiate leases, sell the property, etc.) to reduce loss.
Another chief advantage of Delaware Statutory Trusts is that the lender deals with the trust as the only borrower, making it easier and less expensive to obtain financing. This is in contrast to a TIC arrangement where the lender needs to approve up to 35 different borrowers. Because the loan is obtained by the trust, there is no need for the individual investors to be qualified and their participation in the trust does not affect their credit rating.
Since the investor's only right with respect to the Delaware Statutory Trust is to receive distributions, and they have no voting authority regarding the operation of the property, the investor fraud carve-outs are eliminated. The lender looks only to the sponsor/signatory trustee for these carve-outs from the non-recourse provisions of the loan.
Delaware Statutory Trust investors enjoy limited liability to their personal assets due to the bankruptcy-remote provision of the DST. This means that even in the event that the trust fails and goes into bankruptcy, the most that investors would likely lose is their investment in the trust. Any potential creditors of the trust, or the lender, would be limited by provisions in the trust from reaching the other assets of the investors. Therefore, no LLC entity is necessary to hold a DST investment.
Because a private placement Delaware Statutory Trust offering may have up to 499 investors, the minimum investment amounts are significantly lower. Most DST sponsors will set arbitrary minimum investment levels to limit the number of investors to a manageable number, but cash investments can be as low as $25,000 and 1031 exchange minimums are often $100,000.
Delaware Statutory Trust investors typically have no closing costs associated with the creation of a single member LLC as in a TIC offering, saving as much as $5000 per investment.
Delaware Statutory Trust investors do not have to maintain an LLC by paying annual state filing fees that may dilute cash flows.
The signatory trustee of the Delaware Statutory Trust will generally be the sponsor of the private placement offering or one of its affiliates. Unlike a TIC deal, there is no one-year time limit on the trusteeship or the term of the property manager. This will give the lender comfort that the sponsor will have a continuing presence in operating the property.
A Delaware Statutory Trust also has a Delaware trustee (required by statute), so there is no worry that the trust will inadvertently terminate.