Understanding DST 1031 Exchanges, Part 3

DSTs Reduce TIC Drawbacks

During the 1990s and early 2000s, most 1031 exchange investors who exchanged properties for partial ownership in large, high-valued replacement properties participated in the Tenant-In-Common (TIC) structure.

In contrast to a DST (Delaware Statutory Trust), each TIC investor had deeded title of the property. Though this was a popular investment model, it had many drawbacks for investors. After the recession of 2008, the popularity of TICs decreased significantly because of these drawbacks, and a way was cleared for DSTs to become the new partial ownership structure of choice.

1. DSTs do not require unanimous owner approval.

Perhaps the most significant advantage of a DST structure is that the unanimous approval of the individual owners (investors) is not required in order to deal with unexpected, adverse developments. This prevents delays in decision making and standstills when one investor fails to respond or rejects the proposed action.

2. DSTs are less expensive and are financed easier.

Another chief advantage of the DST structure is that the lender deals with the trust as the only borrower, making it easier and less expensive to obtain financing. For a TIC arrangement, the lender is required to approve up to 35 different borrowers. Because the loan is obtained by the DST, there is no need for the individual DST investors to be qualified, and their participation in the trust does not affect their credit rating.

3. DSTs have no need to sign loan carve-outs.

Since the investor’s only right with respect to the DST 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.

4. DSTs offer limited personal liability.

DST 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.

5. DST investors do not need to maintain an LLC.

In order to limit personal liability, TIC investors are required to maintain an LLC (Limited Liability Company), which can incur set up, annual, and dissolution fees. DST investors do not have to maintain an LLC to protect their personal assets, and, therefore, do not have to pay state filing fees that would dilute cash flows.

6. DST investments have no closing costs.

DST 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.

7. DSTs have a lower minimum investment.

Because a private placement DST offering may have up to 499 investors (in contrast to the 35-investor maximum of a TIC), the minimum investment amounts of DST’s 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.

8. DSTs do not have trustee term time limits.

The signatory trustee of the DST 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.

9. DSTs cannot be inadvertently terminated.

A DST also has a Delaware trustee (required by statute), so there is no worry that the trust will inadvertently terminate.

Investors like the benefits of a DST 1031 exchange, especially for those looking for the tax benefits of a 1031 Exchange. The Internal Revenue Service issued Revenue Ruling 2004-86 on August 16, 2004, which permitted the use of the fractional ownership structure of the DST to qualify as replacement properties as part of an investor’s 1031 Exchange transaction.

Learn More About DSTs



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