DST.EDU Series A- Part 8: Limitations on a DST- “Seven Deadly Sins”

When the IRS cleared the way to uti­lize DST as an accept­able replace­ment prop­er­ty for a §1031 exchange there were stip­u­la­tions regard­ing the struc­ture and func­tion of the DST. Enter the “Sev­en Dead­ly Sins.”

Updat­ed Post: Feb­ru­ary 10, 2024
Orig­i­nal Post Feb 16, 2022

Wel­come DST News! Our goal is to pro­vide non-biased edu­ca­tion and mar­ket infor­ma­tion for Accred­it­ed Investors on Delaware Statu­to­ry Trusts. We hope to pro­vide a Depth & Breath of knowl­edge for Investors About DSTs.

By Al DiNi­co­la, AIF®, CEPA™
DST 1031 Spe­cial­ist
NAMCOA® — Naples Asset Man­age­ment Com­pa­ny®, LLC
Secu­ri­ties offered through MSC-BD, LLC Mem­ber of FINRA/SIPC

Giv­en the struc­ture of the DST with com­mer­cial or res­i­den­tial real estate being the under­ly­ing asset (with a secu­ri­ty wrap­per) there are sev­er­al restric­tions or sit­u­a­tions to under­stand with regards to DST. The DST must adhere to the fol­low­ing pro­hi­bi­tions, which are com­mon­ly referred to as the “Sev­en Dead­ly Sins” (See IRS Rev­enue Rul­ing 2004–86):

• Once the offer­ing is closed, there can be no fur­ther cap­i­tal con­tri­bu­tions to the DST by either exist­ing or new investors.
• The DST can­not rene­go­ti­ate exist­ing loans or bor­row more funds (except in the case of a tenant’s bank­rupt­cy or insol­ven­cy).
• The DST can­not rein­vest pro­ceeds from the sale of its real estate. All pro­ceeds need to be returned to the indi­vid­ual investors.
• The DST is lim­it­ed to mak­ing minor, non­struc­tur­al cap­i­tal improve­ments, in addi­tion to those required by law.
• Any reserves or cash held between dis­tri­b­u­tion dates can only be invest­ed in short-term debt oblig­a­tions.
• All cash, oth­er than nec­es­sary reserves, must be paid out to investors.
• The DST can­not rene­go­ti­ate exist­ing leas­es or enter into new leas­es (except in the case of a tenant’s bank­rupt­cy or insol­ven­cy).

Many of these pro­hi­bi­tions are in place to pro­tect indi­vid­ual investors. There was a brief peri­od (dur­ing the first year of the COVID 19 pan­dem­ic) where the IRS per­mit­ted DSTs (and oth­er sim­i­lar invest­ments) to raise more cap­i­tal. The IRS per­mit­ted a brief peri­od of restruc­tur­ing for cer­tain invest­ments. The rent increase mora­to­ri­um (because of COVID response) affect­ed many small­er land­lords through­out the coun­try. There were a few DST that need­ed to do a brief cap­i­tal raise or invoked oth­er solu­tions for falling incomes in the mul­ti­fam­i­ly prop­er­ties, office, and hos­pi­tal­i­ty. Sur­pris­ing­ly, there were very few seri­ous issues and spon­sors did not need to uti­lize the mod­i­fi­ca­tion of the lim­i­ta­tions.

Dur­ing what was ref­er­enced as the great reces­sion in 2007–2009 TICs (Ten­ants in Com­mon) incurred set back and finan­cial strug­gles that may have been caused by the struc­ture of the TIC. In the TIC struc­ture unan­i­mous agree­ment was need­ed for any deci­sions. This may have caused sev­er­al TICs to suf­fer finan­cial crises while own­ers attempt­ed to decide on a course of action. In the DST struc­ture the spon­sor was able to make crit­i­cal deci­sions that could avoid poten­tial prob­lems.

Look for Part 9: Why Con­sid­er a DST?

DST’s (Delaware Statu­to­ry Trusts) are for accred­it­ed investors only. Con­tact your invest­ment advis­er for addi­tion­al details on how a DST may be a solu­tion to your 1031 Exchange and com­pli­ment your finan­cial objec­tives. 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, in any form, 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.