Delaware Statutory Trusts (DSTs) provide a unique investment opportunity. As a form of fractional ownership, DSTs allow investors to expand their reach to larger properties with a quick and simple process. These trusts provide a chance for real estate investors to enjoy the benefits of ownership without taking on property management responsibilities. They also qualify as a 1031 exchange, offering valuable tax benefits.
On the other hand, not all investors will find DSTs desirable. These investments offer limited control and incur certain risks. In addition, their illiquid nature means they’re only suitable for those interested in a long-term commitment. Before deciding when and how to invest, consider Delaware Statutory Trust pros and cons. Find out if investing in a Delaware Statutory Trust is right for you.
What is a Delaware Statutory Trust?
Before exploring the pros and cons of a Delaware Statutory Trust, it’s vital to understand what a Delaware Statutory Trust is. A DST is a type of real estate investment in which multiple investors each hold a fractional interest in a property. In many cases, each individual investor could not afford total ownership of the property on their own. In that way, DSTs broaden investor capabilities, opening the door to benefits that could be unavailable otherwise.
Investors in a DST have the right to receive distributions from the operation of the trust, either from rental income or from the eventual sale of the property.
Pros of Delaware Statutory Trusts
DSTs have become a popular investment vehicle among real estate investors for various reasons. Whether you are looking for an alternative for your 1031 exchange, or you simply no longer want to deal with the tenants, toilets, trash and other responsibilities that come with traditional real estate ownership, the benefits of DSTs are multifaceted.
1. Offer 1031 Exchange Eligibility
One of the main benefits of a DST is that it can serve as a 1031 exchange, giving the investor access to special tax benefits. Section 1031 of the United States Internal Revenue Service (IRS) Code outlines a taxpayer’s ability to defer capital gains taxes by swapping one property for another. The properties must be “like-kind”, which is defined as “similar in nature, character or class.”
Property must be held for use in trade, business or investment to qualify as like-kind. When you make a 1031 exchange, you keep your investment growing rather than paying out large portions to capital gains taxes. Since there are no restrictions on how many 1031 exchanges you can accomplish, you can defer your tax liability for as long as you wish.
It’s important to understand the limitations on 1031 exchanges. The IRS stipulates that you have 45 days to identify a like-kind property. You must then complete the purchase of the exchange of property within 180 days or the due date of your income tax return. If you’re unable to find a suitable property or close the sale within the respective time limit, you’ll lose your ability to defer your capital gains tax liability. Other limitations regarding the execution of the sale may also apply.
Delaware Statutory Trusts as a 1031 Exchange Property
One way to take advantage of the 1031 code is to invest in a DST. DSTs provide 1031 exchange eligibility during initial investment and upon exit, which offers a unique advantage. In other words, you can invest in a DST to defer the capital gains of another real estate property. Once your DST program ends, you can defer your capital gains again with a new 1031 qualified real estate investment.
A DST 1031 exchange requires a third-party qualified intermediary (QI). The QI must hold and transfer the money involved in the exchange — if you get the profits directly from the property purchaser, you cannot defer the capital gains tax. Finding a reputable third-party entity is an essential part of the investment. You’ll want to choose from well-known, recommended third-party partners.
2. Allow for Capital Gains Deferment
A 1031 exchange allows the investor to defer capital gains, thereby reducing their tax liability. Continuous reinvestment allows you to defer indefinitely. That way, you can keep your investments working for you instead of paying a large portion of every sales profit. You can continue to buy bigger and better properties and build your wealth. DSTs are a convenient way to do so.
3. Handled by Professional Management
One of the reasons you might choose a DST investment over other real estate opportunities is that experienced professionals handle DST properties. A professional real estate company holds the decision-making control, which is ideal for investors who are not real estate experts.
With DSTs, you can rest assured that experts will handle the necessary managerial duties. These responsibilities include managing tenants, overseeing property upkeep and performing regular maintenance.
4. Provide an Efficient Form of Fractional Ownership for Real Estate
A DST is a form of fractional ownership, which allows multiple unrelated parties to share in a high-value asset that may be out of reach otherwise. This method allows investors to access bigger, more expensive properties than they could purchase on their own while mitigating the risk of overextending their financial means. The ability to invest in large properties means you could mitigate risk through portfolio diversification into more commercial projects and enjoy the benefits of investing in larger assets.
DSTs allow investors to acquire fractional ownership of buildings such as:
- Multifamily residential buildings.
- Multi-tenant retail properties.
- Self-storage facilities.
- Industrial properties.
- Multi-tenant office buildings.
These are just a few of the properties that investors can acquire fractional ownership of through DSTs.
Unlike other fractional ownership agreements, DSTs do not require you and the other investors to take on the burden of handling the property. Those responsibilities remain the professionals’. The unique DST structure is more convenient and efficient for investors than handling the burden of traditional real estate ownership.
5. Are Pre-Packaged Offerings
Another major benefit of a DST is that it is a pre-packaged offering, meaning (in most cases) that it has already been acquired. This means the sponsor will have already performed their due diligence gathering and analyzing all the important documents, including inspections, environmental impact reports, rent logs and financial statements. They will have also already established a property management team. A pre-packaged real estate investment does two things for the investor:
- It saves you the time, stress and effort of performing clerical tasks.
- It reduces the risk of missing IRS deadlines for a like-kind exchange.
Because you only have a short window to finalize a 1031 exchange, investing in a pre-packaged offering like a DST can be beneficial. Other investments may take much longer to complete, risking your ability to qualify for a capital gains tax deferment.
6. Are an Equitable Asset
Another advantage of a DST is that it offers equitable titles to all investors. Equitability is a major advantage of DSTs because all investors benefit from property gains. Other types of investments may not provide equitable titles. For instance, stockholders of a corporation do not own the properties the corporation owns.
7. Allow You to Diversify Investments
Diversification is vital for any investment portfolio — it mitigates risk and maximizes the potential of greater returns. DSTs allow for diversification because you can put relatively small investments into high-value properties. Because the entry costs are lower than they would be if you were purchasing entire properties, you may be able to invest in multiple DSTs or include a DST in a broader portfolio. DSTs are an easier asset to manage since decision-making remains the responsibility of the property management team.
Cons of Delaware Statutory Trusts
Although many investors find DSTs useful and desirable, they do have possible disadvantages. Like any investment offering, DSTs incur certain risks that are vital to consider. In addition, the nature of a DST, as a fractional purchase offering limited control, may not be compelling to all investors. It’s necessary to understand a DST’s potential cons before deciding whether or not to invest. Some of the potential downsides of DSTs can include:
1. Loss of Control
When you invest in a DST, the IRS does not allow you to have direct operational control of the property, so you have no decision-making power. This restriction keeps investors from having conflicting interests. Some investors take issue with this stipulation and would rather invest in properties that allow them to gain operational control.
With that said, restricted control can also be an advantage. Investors with large portfolios or expertise unrelated to real estate will not have the time or ability to take on managerial duties. With a DST, these investors need not worry about that aspect of real estate investment. In addition, leaving the control in the hands of real estate management experts may help protect the investment.
2. Execution Risks
Delaware Statutory Trust risks can also be related to execution. DST 1031 exchanges require you to complete a transaction in a short timeframe and, while this characteristic can be beneficial to investors, there is little room for error. One misstep could render the exchange no longer viable. Again, the best way to mitigate this risk is to work with an expert partner with a record of successful 1031 exchanges. They can help you understand the process and help you select a reputable intermediary.
3. Economic Risks
DSTs incur many of the same economic risks as traditional real estate investments. How well a property performs depends on its asset class and the property manager, but it may also rely on other factors. For instance, the health of the national economy, which can be unpredictable, influences the real estate market. A period of recession may affect your DST returns. With that said, DSTs offer limited liability. If a trust fails or goes bankrupt, an investor can only lose their initial investment.
Another potential downside to DSTs is their illiquidity. While liquid assets are easy to sell or exchange for cash at a moment’s notice, DSTs and other real estate investments usually require a long-term commitment. Investors who need or prefer a quick return should consider other ventures, like a publically traded Real Estate Investment Trust (REIT).
Before choosing a DST, ask yourself if you’re able and willing to hold the investment for the duration of the program, which may last an average of five to 10 years. If you decide you want to sell your ownership before the end of the program, you may run into issues finding a buyer and agreeing on a price.
For that reason, you may want to consider possible exit strategies before investing. Determine institutions or other investors who might be willing to buy your DST share should you need to exit the program. Another potential option is our DST Secondary Market. We can offer your DST investment on our platform, as well as email our extensive network of Accredited Investors. Call us today at (844) 533-1031 to see if your investment qualifies. Ideally, you should make sure you’re ready for a long-term commitment before choosing a DST or any other illiquid investment.
5. Accredited Investor Requirement
In order to invest in a DST, you must be an accredited investor. The Securities and Exchange Commission (SEC) accredited investor standard is that the individual must make a yearly income of $200,000, or a joint income of $300,000 or more. Net worth over $1 million, regardless of income, can also qualify someone to be an accredited investor. Investors who don’t meet these requirements have to seek out investment strategies.
6. Regulatory Risks
One of the biggest challenges for 1031 Delaware Statutory Trust investors is that the IRS and Congress have set strict regulatory constraints on all 1031 exchanges. It can be difficult to ensure your 1031 exchange is compliant with IRS guidelines, and failure to do so could incur financial and legal penalties. Make sure you have a thorough understanding of 1031 exchanges and the restrictions upon them.
Keep in mind, tax laws and restrictions are always subject to change, so it’s essential to remain informed for the duration of your investment. Investors find it helpful to work with a reputable partner with expertise in like-kind exchanges. For instance, 1031 Crowdfunding specializes in tax-deferral investments like 1031 exchanges.
Contact 1031 Crowdfunding to Learn More
If you’re looking for a way to diversify and maximize your investment portfolio, a Delaware Statutory Trust might be the right choice for you. DSTs offer a real estate ownership opportunity unlike any other. They allow investors to enjoy fractional ownership of high-value property, without requiring the time, effort or further capital demands of real estate management. They also allow investors to defer tax liabilities upon both entrance and exit. As a prepackaged offering, a DST can be utilized as a fast and convenient way to complete a 1031 exchange.
With that said, all investments have limitations and risks, and DSTs are no exception. DSTs are not liquid assets — like other real estate investments, they require a long-term commitment. In addition, DSTs can incur regulatory, execution and economic risks. All 1031 exchanges are subject to strict deadlines and other procedural restrictions. One way to minimize these risks is by choosing the right platform and service.
Consider 1031 Crowdfunding as your DST partner. Here at 1031 Crowdfunding, we offer the largest inventory of DSTs, as well as a proprietary model for customized 10-year targeted returns. We simplify and streamline the DST investment process with our easy-to-use online investors portal. We’re the number one rated real estate crowdfunding platform for 1031 exchanges. We’d be happy to share additional information about DST investments — contact us today to learn more.