Over the last 12 – 18 months, the Exchange Team here at 1031 CORP. has seen a significant increase in Exchangers pursuing more passive investment opportunities with a desire to leave the three Ts of hands-on property management: tenants, toilets and trash. While these three Ts have helped many real estate investors build wealth, there often comes a point when they are ready to leave it behind but they still want the benefits of owning investment real estate and don’t want to have to pay the tax when they sell. This More, More Monday looks at the increasingly popular Delaware Statutory Trusts, (DST), and how they offer an alternative to active real estate management.
A DST is a separate legal entity created as a trust under Delaware state law. Each owner of the entity has a beneficial interest in the DST and is treated as owning an undivided, fractional interest in an individual property or portfolio of larger commercial or residential properties. For 1031 exchange purposes, this fractional interest is treated as a direct interest in real estate and provides each owner with the potential for annual appreciation and depreciation of the property while deferring capital gains taxes.
DSTs offer the same benefits and risks as owning larger scale properties and they require the same due diligence. Some of the benefits that attract today’s investors include:
- Less management responsibilities: DST Sponsors perform the functions of overall asset and investor relations management, including day-to-day operations;
- Readily available: There are typically many DST offerings for a wide variety of property classes and locations throughout the United States which helps simply the 45-Day Identification process;
- Diversification of assets: Exchangers can invest in a diversified selection of properties including multifamily, industrial, office buildings, retail, medical offices, apartment communities, single tenant retail properties and so on. The properties can be locates throughout the U.S. providing greater risk protection;
- The ability to invest an amount that makes sense to you: DSTs provide the ability to invest the dollar amount that makes sense for you, including some as low as $100 – 200K. There are offers of DSTs that are free and clear and some that include debt;
- Non-recourse financing: If the DST includes financing, it is likely already in place and secured by the DST Sponsors. Loans are typically at a low fixed rate and non-recourse, meaning the Exchangers are not personally liable for repayment and it will not affect their credit.
Revenue Ruling 2004-86 underlines that only passive real estate qualifies for Section 1031 treatment in a DST. Essentially, each owner has the right to receive allocations from the operation of the trust in the form of rental income or sale proceeds but they do not have any authority on the day-to-day operations of the property or hold the deeded title. The entity itself has the deed to the property, the DST Sponsor manages operations and only the signatory trustee can make decisions on the relinquishment of the property.
As an increasingly popular type of replacement property in a 1031 exchange, it can provide a stream of passive income as well as the ability to diversify your real estate portfolio without the stress of hands-on management. Our Exchange Team has seen Exchangers choose to exchange knowing they will invest their funds in a DSTs and we have seen other Exchangers identify a DST interest when there were unsuccessful finding desired replacement property within their 45-Day Identification Period. Regardless, a DST can provide the perfect replacement property solution. When considering a DST, it is essential to keep in mind they don’t provide the same liquidity as traditional real estate. You should enter into the agreement knowing it is going to be a five to eight year investment or more based on the investment plan of the DST sponsor. For a list of DST brokers, contact our Exchange Team.