3 Reasons to Use DSTS in 1031 Exchanges

posted on September 8, 2018

For accredited investors who want a tax-efficient way to preserve the equity they have earned by investing in real estate, a DST (Delaware Statutory Trust) used in an IRC §1031 exchange offers significant advantages such as:

• Deferral of capital gains and recapture of depreciation taxes
• Ease of replacement property identification (45 days goes by quickly!)
• Pre-arranged, non-recourse debt (not all DSTs have debt)
• Closings are completed in as few as 3 to 7 days
• Diversification through low minimum required investments ($100,000 for most DSTs)
• Freedom from landlord responsibilities—no more tenants, toilets, or trash!

Whether it’s the right choice for you depends on a few factors, including your comfort level with not being involved in the daily management of the property or a say in major decisions, such as when to sell the property. For many investors, that’s a DST’s greatest appeal.

What Are Delaware Statutory Trusts?

If you’re not familiar with the phrase or have heard it but aren’t sure what it means, a Delaware Statutory Trust is a business trust established under Delaware law. Investors own an undivided beneficial interest in the trust; the trust owns the real estate. The investors share in the overall financial performance of the investment property or properties on a pro-rata basis.

How can you be sure that a DST qualifies as like-kind property in 1031 Exchanges? IRS Revenue Ruling 2004-86 sets forth the relevant conditions, with each offering containing a written tax opinion verifying that these IRS conditions have been met. The tax opinion is usually found in the PPM, or Private Placement Memorandum.  

For an interest in a DST to be treated as a direct interest in real estate for Section 1031 Exchanges, the IRS stipulates that the trust must not violate the following conditions, often referred to as the “seven deadly sins:”

1. Once the offering is closed, there can be no future capital contributions to the DST.
2. The trustee cannot renegotiate the terms of the existing loans, nor can it obtain new financing except when a property tenant is bankrupt or insolvent.
3. A trustee cannot enter new leases, or renegotiate existing leases, except when a property tenant is bankrupt or insolvent.
4. A trustee cannot reinvest the proceeds from the sale of its real estate.
5. A trustee is limited to making the following types of capital expenditures with respect to the property: expenditures for normal repair and maintenance of the property; expenditures for minor non-structural capital improvements of the property; and expenditures for repairs or improvements required by law.
6. Any cash held between distributions can only be invested in short-term debt obligations.
7. All cash, other than necessary reserves, must be distributed on a current basis.

Fewer Responsibilities

If you like the idea of monthly income from commercial property but want to switch from an active landlord role to a more passive one, exchanging into a DST is a smart way to do it. Instead of directly dealing with tenants, property improvements, taxes, mortgages, and other liabilities, you can have ownership in one or more professionally managed properties, including:

• Multifamily apartment communities
• Student and senior housing
• Medical office, clinics, and hospitals
• Single-tenant, net leased retail (individual or in portfolios)
• Self- storage facilities
• Industrial buildings (often mission critical)

Simplified Group Investment

There are two important ways using a DST makes owning investment real estate less stressful.

1. Because your agreement is with the trustee of the DST, you’re not threatened by the actions of any other investor. You have the advantage of sharing the investment burden but are shielded from liability with respect to the underlying investment property and have none of the risk associated with a rogue investor.
2. A DST is less expensive than a TIC (tenant-in-common), there’s only one agreement you need to execute, and there’s no need for a special purpose entity to be formed and maintained. A single loan is made to the DST trustee, not to each investor. And because there is no IRS-imposed limit on the number of investors in a DST (TICs are limited to 35), the minimum required investment can be much lower, providing you the opportunity to diversify into more than one DST.

Diversified Investment Opportunities

Traditional 1031 Exchanges allow you to grow the value of your portfolio, but if you simply exchange one property for another it does little to help you diversify. A DST lets you pool your funds with other investors to invest in multiple institutional quality replacement properties. And you’re not limited to one geographic location or type of property.

Potential Disadvantages of DST Ownership

When you choose a DST, you are making an investment in real estate. And like any real estate investment, it’s subject to market value, tenant issues, rental income fluctuations, vacancies, taxes and governmental regulations.

Other potential disadvantages include:

• Added costs and fees specific to a DST investment.
• As a DST owner, you do not maintain management control, dictate day-to-day property management operations, nor have control over decisions such as when to sell the property.
• DST ownership is subject to IRS regulations that may affect the management of the property and your ownership interest.
• Finally, DST investments are highly speculative and involve substantial risks. No public market is likely to exist for such investments.

Learn More

Because DSTs are uniquely structured, you can access a greater variety of investment properties, diversify your portfolio, and forego property management responsibilities and headaches that often come with traditional ownership.

There is no dollar price you can put on quality of life. After actively managing real estate for a good part of your real estate investment life, exchanging into a DST frees you to enjoy the fruits of your labor without being tied to a landlord’s duties. For many people, a DST offers the ideal solution to a true retirement way of life.

At Turner Investment, we specialize in providing investors access to investment real estate through DSTs and traditional ownership. To learn more about whether a DST is the right investment choice for you, contact us today. We’d love to talk with you about your options.