Is A Delaware Statutory Trust 1031 Exchange Right for You?

Investors who sell their real estate uti­liz­ing a 1031 tax deferred exchange may also defer cap­i­tal gains into the next real estate invest­ment.  Iden­ti­fy­ing if a Delaware Statu­to­ry Trust (DST) may be an invest­ment strat­e­gy becomes the ques­tion.

By Al DiNi­co­la, AIF®, CEPA ™
adinicola@namcoa.com
Sep­tem­ber 9, 2023
DST 1031 Spe­cial­ist
NAMCOA® — Naples Asset Man­age­ment Com­pa­ny®, LLC
Secu­ri­ties offered through MSC-BD, LLC

Ever since becom­ing involved with Real estate over 40 years ago, real estate has been favored by investors.  In addi­tion to own­ing a pri­ma­ry res­i­dence (many con­sid­er an invest­ment) own­ing invest­ment prop­er­ty has demon­strat­ed the abil­i­ty to gain cer­tain tax advan­tages, poten­tial pas­sive income, and poten­tial appre­ci­a­tion.  When there are ben­e­fits of own­ing real estate there are also respon­si­bil­i­ties as well.

The §1031 tax deferred exchange has pro­vid­ed many investors with a sol­id strat­e­gy for invest­ments. There is an addi­tion­al strat­e­gy involv­ing a DST that can accom­plish the same defer­ral of cap­i­tal gains and also remove many of the respon­si­bil­i­ties of own­ing invest­ment real estate.

A Delaware Statu­to­ry Trust (acronym DST) may be defined as a sep­a­rate legal enti­ty cre­at­ed to hold frac­tion­al own­er­ship and assets of a trust.  A DST spon­sor (typ­i­cal­ly an expe­ri­enced real estate com­pa­ny) iden­ti­fies, research­es, and acquires real estate assets.    

The list of poten­tial DST prop­er­ties can include any com­mer­cial prop­er­ty. Com­mer­cial prop­er­ties may include mul­ti­fam­i­ly (apart­ments), office, self-stor­age, indus­tri­al, stu­dent hous­ing, senior hous­ing and even land in some cas­es. One of the first com­par­isons may be a DST looks much like a Real Estate Invest­ment Trust (REITs). DSTs qual­i­fy for §1031 but REITs do not.

Investors have been able to own real estate in a frac­tion­al inter­est for some time. The DST can enable investors to own in a Trust vehi­cle (cre­at­ed by the Spon­sor) that pro­vides ben­e­fits to the investors. The prop­er­ty or asset in the DST is pro­fes­sion­al­ly man­aged and enables the investor to enjoy pas­sive respon­si­bil­i­ty as well as pas­sive income. Cash investors do make invest­ments in DST. How­ev­er, many investors uti­lize a DST when com­plet­ing a §1031 tax deferred exchange.

DST §1031 Exchanges 20-year track record

Under­stand­ing how the §1031 exchange works in con­junc­tion with a DST becomes an edu­ca­tion­al process.  Once under­stood some investors see the syn­er­gy of the offer­ing. Investors research which spon­sors and asset class they may wish to ulti­mate­ly invest in when they sell their exist­ing prop­er­ty and ulti­mate­ly close on their replace­ment prop­er­ty.

The respon­si­bil­i­ty of the Trust is to “pack­age” the offer­ing. This starts with find­ing the invest­ment, arrang­ing for debt/financing if applic­a­ble, clos­ing on the prop­er­ty, hir­ing the nec­es­sary man­agers and many oth­er active respon­si­bil­i­ties. You as an investor would own an inter­est in the prop­er­ty (ref­er­enced as a frac­tion­al inter­est).

Pas­sive income dis­trib­uted.

Investors will receive pas­sive income dis­trib­uted on a reg­u­lar basis (month­ly or quar­ter­ly) from the asset or prop­er­ty. This income is con­sid­ered pass through, and indi­vid­ual own­ers are taxed at their reg­u­lar rates.  DST can qual­i­fy as a 1031 tax deferred vehi­cle (fol­low­ing all the guide­lines).  The DST process is reg­u­lat­ed in struc­ture and func­tion.

“Green Light” §1031 using a DST?

In 2004 DSTs were approved as a rec­og­nized alter­na­tive to tra­di­tion­al real estate for IRC §1031. Specif­i­cal­ly cap­i­tal gains tax­es can be deferred by investors on the sale of cer­tain invest­ment prop­er­ties. The Inter­nal Rev­enue Code when issu­ing Rev Rul­ing 2004–86 enabled DSTs to be an alter­na­tive replace­ment prop­er­ty when uti­liz­ing a §1031 exchange.

Cau­tion- There are Rules & Strict Guide­lines

There are tim­ing rules, prop­er­ty rules, and finan­cial rules.  As to the tim­ing there are two impor­tant dates or num­bers of days.  As with all §1031 exchanges (includ­ing using a DST) you must iden­ti­fy poten­tial replace­ment prop­er­ties with­in 45-days of sell­ing your relin­quished prop­er­ty.  You must then close on one or more of the prop­er­ties iden­ti­fied with­in 180 days of clos­ing on your relin­quished prop­er­ty.

The prop­er­ty rules are most lenient. You may hear the word “like kind”. Sim­ply put, this is real estate for real estate. You may do a 1031 exchange sell­ing a farm (exclud­ing the pri­ma­ry farm­house res­i­dence) into an apart­ment build­ing.

The finan­cial rules have a twist. You need to invest in a replace­ment prop­er­ty of equal or greater val­ue.  You accom­plish this by using all the cash pro­ceeds and replac­ing any debt that was paid off on the relin­quished prop­er­ty sale. This is one of the rules that trips peo­ple up.

Triple Options

The DST strat­e­gy enables an investor to review more options than what is pro­vid­ed by tra­di­tion­al real estate. DSTs may pro­vide mul­ti­ple replace­ment prop­er­ties by the nature of the DST struc­ture. Pro­ceeds from the sale of the relin­quished prop­er­ty maybe split into mul­ti­ple DSTs because of the low bar­ri­er to entry pro­vid­ed by the DST.  The min­i­mum invest­ment typ­i­cal­ly is $100,000. There are also asset class diver­si­fi­ca­tions as well as geo­graph­ic.  In a reg­u­lar §1031 exchange after the 45-day iden­ti­fi­ca­tion peri­od investors may be wait­ing to close based on a num­ber of con­tin­gen­cies includ­ing inspec­tions, mort­gage approvals and oth­er issues that may jeop­ar­dize the suc­cess­ful clos­ing of the exchange.  With a DST once a prop­er­ty is iden­ti­fied and the investor has their cash with the Qual­i­fied Inter­me­di­ary (QI) clos­ing can occur with­in a mat­ter of days.

One or more DSTs

Over the years investors have decid­ed on which style of DST investor they pre­fer to be.  We have investors (uti­liz­ing a §1031 exchange) sim­ply doing a one for one exchange.  Sell­ing a $1.5M prop­er­ty and invest­ing into a $1.5M DST. We also have investors who may sell a $1.5M prop­er­ty and exchang­ing into 5–6 DST in dif­fer­ent geo­graph­i­cal loca­tions (TN, TX, NC, FL) as well as dif­fer­ent asset class­es (self-stor­age, mul­ti­fam­i­ly, etc.).

Top Rea­sons to con­sid­er a DST as 1031 Exchange Replace­ment

The main rea­son for doing a §1031 exchange may be to defer cap­i­tal gains. There are oth­er rea­sons when decid­ing if a DST is right for you.

• Cap­i­tal Gains defer­ral may be at the top of the list. This includes the defer­ral of depre­ci­a­tion recap­ture as well as defer­ral of state income tax.
• Low Risk of Exchange Fail­ure. This may be the biggest ben­e­fit to the investor.  DSTs are prepack­aged as some­what sit­ting on the shelf and may also have replace­ment non-recourse debt assign­a­bil­i­ty if need­ed.
• Mit­i­gat­ing risk becomes an addi­tion­al focus for investors. Time­lines as well as match­ing required replace­ment val­ue is near­ly elim­i­nat­ed.
• For an investor look­ing to be relieved of man­age­ment respon­si­bil­i­ties this is a per­fect fit.
• DSTs are typ­i­cal­ly very large prop­er­ties and out­side the reach of many indi­vid­ual investors.  DST pro­vides access to insti­tu­tion­al grade invest­ments.
• Diver­si­fi­ca­tion can­not guar­an­ty safe­ty. How­ev­er, DSTs pro­vide a vast selec­tion of assets as well as geo­graph­ic loca­tions.
• Dis­tri­b­u­tion from rents received typ­i­cal­ly are pro­ject­ed month­ly.
• Tax advan­taged income.

What is your best option? It depends. Real estate investors have acknowl­edged a §1031 exchange is a valu­able tool. Using a DST as replace­ment prop­er­ty can pro­vide pas­sive income as well as relieve you of any land­lord respon­si­bil­i­ties.  If you would like to have a con­ver­sa­tion about your options, please reach out to us. We are well expe­ri­enced at pro­vid­ing edu­ca­tion­al insight. Give us a call.

DSTs are not for all investors.

The acqui­si­tion of a DST is for accred­it­ed investors only. Con­tact your invest­ment advis­er for addi­tion­al details on how a DST may be a solu­tion to your 1031 Exchange and suit­ed for your invest­ment future. For more infor­ma­tion on how to prop­er­ly set up an IRC 1031Tax Deferred Exchange or if you are an accred­it­ed investor and would like addi­tion­al infor­ma­tion on a DST con­tact Al DiNi­co­la at 239–691-8098 or email adinicola@namcoa.com.

This is not an offer to pur­chase or solic­i­ta­tion to pur­chase any secu­ri­ty, as such be made only through an offer­ing mem­o­ran­dum or prospec­tus. Invest­ing in secu­ri­ties, real estate, or any invest­ment, whether pub­lic or pri­vate, involves risk, includ­ing but not lim­it­ed to the poten­tial of los­ing some or all of your invest­ment dol­lars when you invest in secu­ri­ties. You should review any planned finan­cial trans­ac­tions that may have tax or legal impli­ca­tions with your per­son­al tax or legal advi­sor. NAMCOA, LLC is a Reg­is­tered Invest­ment Advi­sor, reg­u­lat­ed by SEC (Secu­ri­ties and Exchange Com­mis­sion). Our cor­po­rate office is locat­ed at 999 Van­der­bilt Beach Road, Suite 200, Naples Flori­da 34108. Secu­ri­ties Offered through MSC-BD, LLC, Mem­ber of FINRA/SIPC. 8215 SW Tualatin ‑Sher­wood Rd, Suite 200 Tualatin, OR 97062. MSC-BD, LLC and NAMCOA are inde­pen­dent­ly owned and are not affil­i­at­ed.

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