DST 101

Providing Flexibility and Beneficiary Advantages for 1031 Exchange Investors

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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.

As a co-ownership system, a DST allows investors to benefit from property investment gains without being responsible for management. With a Delaware Statutory Trust 1031 exchange, the trustee takes on the legal title and management responsibilities, while the investors serve as beneficiaries with the equitable title.

Through co-ownership, it's possible to fractionally invest in larger properties, such as medical offices, industrial properties or multifamily apartment communities that might be too costly to purchase in full. A DST expands the options investors have for replacement properties to meet 1031 criteria, allowing for more diversification. Finding eligible properties may also be less time-consuming because investors have more options for acquiring one or more properties.

To get a DST 1031 property, an investor must work with a Qualified Intermediary (QI) to handle the exchange. The stipulation is that a third party not affiliated with the seller or buyer must hold and transfer the money to complete the exchange. The investor cannot directly receive the money from the first property sale.

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

What is the benefit of a DST? Many investors choose a DST because it offers potential returns on real estate holdings without many of the complications of property management.

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.

Acquiring a DST property relieves investors of the responsibilities of sole ownership. Instead of being responsible for tenant complaints, facility issues and other considerations, DST investors are only responsible for contributing their share of the investment.

Risks and Potential Problems With a Delaware Statutory Trust

Before making any investment decisions, it's very important that every DST investor understand the things that can potentially go wrong with a DST.

The IRS ruling that formed the basis for DST use in a Section 1031 exchange transaction placed some prohibitions on the powers of the trustee and have become known as the “seven deadly sins”:

  • Accept contributions to the DST after the period for soliciting investments is over.
  • Renegotiate the terms of existing loans or borrow new funds.
  • Reinvest proceeds from real property sale or acquire new real property.
  • Invest any cash to profit from market fluctuations.
  • Make any unnecessary property modifications unless required by law.
  • Renegotiate any master lease or enter into a new lease on the property.
  • Fail to distribute cash profits regularly.

Among other factors, the impact of these restrictions is evident in the financial structuring of all DSTs and they typically best suit master lease transactions where the master tenant takes on all the operating responsibilities (triple net lease or net long term lease) with a financially stable tenant. DSTs should also have sufficient ongoing reserves, as well as a disposition plan for asset sale prior to any financing becoming due as loan modifications may not be possible.

Over the years we have seen DSTs in all shapes and sizes and can point out some of the problematic aspects to which we pay close attention:

When you choose to invest in a DST you are fundamentally relying upon the sponsor for their continued competency and success. The sponsors typically work with property managers and operators who implement the business plan to increase income and lower expenses. On the other hand, they continually survey the market for sales opportunities as they’ll manage disposition. Additionally, they should periodically communicate with investors and keep them abreast of material operational events.

All real estate investments are speculative in nature and there are many unknown future factors, including but not limited to, economic, market, tenant default, interest rate, and environmental issues that could impact the underlying asset value. Potentially, there could be a variety of consequences such as holding period extensions or loss of value. We help our clients mitigate these risks with strong upfront DST due diligence efforts followed by thoughtful portfolio diversification strategies.

There is no assurance that a property will perform as projected and DSTs are subject to economic volatility, tenants not paying their rent timely, and other traditional risks of owning and operating real estate. Forecasted cash flows are typically conservative in nature, but they are not guaranteed and there is potential for reduction or suspension of cash flow distributions.

DSTs generally have target hold periods ranging from 3 to 10 years, although market conditions could dictate a significantly different actual hold period. A DST investment should be viewed as illiquid while invested in the property and early exit by an investor for liquidity purposes may not be possible or may be only possible at a significant discount to the trust’s net asset value.

This type of risk is dependent on macro interest rate trends and is most often associated with DSTs that have longer-term leases, such as retail and office properties in which the property is locked into a pre-agreed upon rental rate. The risk can be mitigated by investing in DSTs with shorter-term leases, such as multifamily apartments as rent can be adjusted with the market.

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There is risk of potential conflicts of interest among the various parties involved in a DST program that could adversely affect the investment.

There may be significant fees and expenses associated with the purchase and ownership of a DST. In some cases, the fees and expenses may outweigh the benefits of conducting a 1031 exchange and purchasing a DST.

Failing to properly meet all of 1031 exchange requirements could lead to significant tax consequences. Investors should consult their legal and tax professionals before engaging in a 1031 exchange, including a 1031 exchange into a DST.

Why Partner With Us?

Investors choose 1031 Crowdfunding because we offer a turnkey solution to 1031 exchanges in addition to a wide selection of DST properties. We make it more convenient and efficient to find eligible properties that meet your financial investment goals and the 1031 exchange criteria. With our experienced team and carefully curated network of corporate partnerships, we have the versatility and insight to handle the demands of the real estate market while providing outstanding client support.

With 60 combined years in the securities industry and 65 combined years in real estate, our team brings extensive expertise to meet each client's needs. We also have a record of $2 billion in combined real estate transactions, which shows how we've delivered on our commitment to serving clients over the years.

Instead of closing on a replacement property in 180 days, many of our clients close in 3-5 days. Our marketplace platform offers an accessible way to identify and acquire a property more easily. With pre-vetted properties available, we can streamline the process from initial identification to closing, helping to significantly reduce the time and effort that goes into making the final investment decision.

Join the Crowd

As an investor, you need accessible options to pursue your financial goals. Partner with us to save time and effort while meeting the complex requirements of a 1031 exchange. When you work with 1031 Crowdfunding, our experienced professionals will guide you through the steps of the DST 1031 exchange process, making your exchange smoother and less stressful.

Start finding investment opportunities and Join the Crowd today.

AUTHORIZED PARTNER

CrowdPay is an FDIC insured bank account that you can use to purchase investment opportunities. You fund your CrowdPay account by ACH or wire transfer. All future dividends, interest payments, as well as revenue sharing payments will be placed into your CrowdPay account. You have the option to transfer funds into the account, withdraw funds from the account, or purchase additional assets at any time.

The account is held by GoldStar Trust Company, a trust only branch of Happy State Bank, and cash that accumulates in your new CrowdPay account is FDIC insured. Please follow the below link for additional important information regarding your CrowdPay account.

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