InSight

Using a Delaware Statutory Trusts (DST) with 1031 Exchange Investments

Financial Planning Dentist

Delaware Statutory Trusts (DSTs) are extremely popular with 1031 exchange investors. In addition to the tax mitigation aspects of the 1031 itself, they allow investors to diversify the make-up of an investment portfolio, access new buildings and investment types, and easily scale up or down the size of their real estate portfolio.

1031 exchange investors favor DSTs due to the fact that it can be difficult to identify a replacement property within 45 days and in most cases, the DST can accept the exact balance investors are looking to replace a part of the 1031 Exchange. 

What is a Delaware Statutory Trust?

The name will usually confuse new investors. The “Delaware” in Delaware Statutory Trusts is simply a component of the law being initially conceived and developed in Delaware. A common state for incorporation and legal standing. 

The use of the DST structure helps keep the title clean in connection with ownership by many co-investors. It separates the investor holding title individually into a holding in a new trust where the investor is the beneficial owner. The trustee of the trust can take actions on behalf of the trust beneficiaries (i.e. the DST investors/owners) which does not require agreement by all. 

Why invest in a DST?

Few investors have the requisite net worth to own a 30-story office complex and keep the real estate exposure for their portfolio in line with their risk expectations. That is where the use of DSTs comes into play. A DST is attractive to an investor who desires access to a single property or portfolio of high-value, high-quality real estate asset(s) that may not otherwise be available to them due to size or service constraints. 

A DST puts the management and ownership of a real estate venture into a manageable box for most investor types. Collecting income, managing taxes, and maintaining the risk are all far easier in the real estate space through the DST structure. The investor receives a deeded fractional ownership in the property in a percentage based upon the equity invested. 

Is a DST like a REIT?

It has some characteristics of a REIT or Real Estate Investment Trust but is different, including the fact that it is often, but not always, just a single property. In addition, the owner of REIT shares holds a partnership interest in the underlying real estate investment. Partnership investments do not qualify for 1031 exchange investments, even if the underlying asset consists of real estate.

How does the DST provide income?

Similar to the other real estate investments, DSTs generally pay monthly or quarterly an amount based on the excess rent over the property expenses. This includes any mortgage payments so as the debt service is paid, the equity ownership of the investor shifts as well. The Return on Equity (RoE) varies from deal to deal based on the specifics of the property, the building type, and financing goals. With most deals, the sponsor knows the net rent that can be expected and can give the investor the anticipated return for the term of the investment. 

How long does the DST operate?

Most DSTs have a well-defined expectation for liquidation of the asset. The asset’s holding period varies and is prescribed in the beginning, but most have an intermediate time frame. Usually, 3-7 years and the investor shares in the same percentage basis the appreciation in value upon sale of the property. 

How does the liquidation work?

This final stage of a DST is a complete liquidation of the Real Estate assets. This is also part of the investor’s stake in the holding. This can increase the overall annualized return by a couple of percentage points and is paid out in cash upon liquidation. 

While most investors seek out real estate for the prospect of a current and predictable income – tax mitigated capital appreciation as part of the real estate investment is typically the larger portion of the total return of the investment. 

Who can buy into a DST?

The manner in which DSTs are marketed to the public has a lot of characteristics of sales of securities. Over time, the SEC decided to regulate them as actual sales of securities. So, although a DST interest retains the nature of real estate ownership, with some exceptions, they are regulated. They are typically brought to market for syndication by large well-known sponsors, although they have to be acquired through a Broker, Registered Investment Advisor, or a licensed Financial Advisor. 

The DST structure usually, if not always, requires the investor meets the Accredited Investor standard as the offerings are listed through the Reg D issuing process. Typically, the broker or advisor will vet all offerings of the sponsors with whom they have an agreement and that level of due diligence is a benefit to the investor who is unlikely to have the wherewithal to review the investment as closely. 

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