Introduction to Delaware Statutory Trusts (DSTs): Exploring the Basics and Purpose

Over the past five years the pop­u­lar­i­ty of Delaware Statu­to­ry Trusts (DSTs) has increased in investor aware­ness. DSTs have also become part of estate plan­ning, cash investors, as well as a viable solu­tion or replace­ment in a §1031 tax deferred exchange.

Feb­ru­ary 19, 2024
By Al DiNi­co­la, AIF®, CEPA™
DST 1031 Spe­cial­ist
NAMCOA® — Naples Asset Man­age­ment Com­pa­ny®, LLC
Secu­ri­ties offered through MSC-BD, LLC Mem­ber of FINRA/SIPC

Intro­duc­tion:

Many times we (as advi­sors) find our­selves assist­ing investors who may not have planned well and seek­ing DST advice near­ly at the 11^th hour when involved in a §1031. We have been suc­cess­ful in pro­vid­ing infor­ma­tion on DSTs. DSTs have been wide­ly used for the tax advan­tages cre­at­ed by their unique struc­ture. DSTs cre­ate an effi­cient way for investors to par­tic­i­pate in real estate own­er­ship and many investors like the flex­i­bil­i­ty DST pro­vides.  We will pro­vide an overview of the key ele­ments and fea­tures of the Delaware Statu­to­ry Trusts. This may be just an overview of the basic pur­pose and how investors may ben­e­fit.

Under­stand­ing Delaware Statu­to­ry Trusts:

The State of Delaware pro­vides for the A Delaware Statu­to­ry Trust (DST) to be estab­lished as a legal enti­ty. Under the Trust mul­ti­ple investors (who do not know each oth­er) are per­mit­ted to acquire real estate. Real estate is acquired through indi­vid­ual investors con­tribut­ing (pool­ing) their finan­cial resources. The pur­pose is to own and man­age real estate prop­er­ties.  The DSTs pro­vide a struc­ture that is orga­nized to pro­vide ben­e­fits to the indi­vid­ual investors.

Key Fea­tures of DSTs:

Pass-Through Enti­ty:

A com­pa­ny that pays tax­es sole­ly on its own­ers; tax returns is known as a pass-through enti­ty. Busi­ness­es are either pass-through enti­ty or C cor­po­ra­tions for tax pur­pos­es. DSTs enjoy the pass-through enti­ty sta­tus. DSTs do not pay fed­er­al income tax at the enti­ty lev­el. Part­ner­ships, LLC and oth­er enti­ty struc­tures enjoy this same advan­tage.  The investor share of income, deduc­tion, and oth­er real estate (tax) advan­tages go to the indi­vid­ual own­ers of the DST. The investor will report these items on their indi­vid­ual fed­er­al tax returns as well as state returns if applic­a­ble. 

Frac­tion­al Own­er­ship:

There are two typ­i­cal frac­tion­al own­er­ship struc­tures: Ten­ants in Com­mon and DST. The frac­tion­al own­er­ship struc­ture enables indi­vid­ual investors the abil­i­ty to pur­chase an inter­est in a larg­er real estate prop­er­ty. Investors may not have the abil­i­ty to invest in larg­er and poten­tial­ly invest­ment grade prop­er­ties. Investors may view the larg­er prop­er­ties as poten­tial­ly more lucra­tive than small­er real estate prop­er­ties they would pur­chase on their own. You may hear the words “ben­e­fi­cial inter­est” inter­changed with frac­tion­al inter­est.

Pro­fes­sion­al Man­age­ment:

Frac­tion­al own­er­ship may cre­ate prob­lems with­out pro­fes­sion­al man­age­ment. Pro­fes­sion­al man­age­ment releas­es the investor from any respon­si­bil­i­ties for the day-to-day oper­a­tions of the prop­er­ty man­age­ment. Cer­tain investors may rel­ish the pas­sive nature of the invest­ment. This bur­den of own­ing real estate (prop­er­ty man­age­ment) may restrict investors from own­ing real estate. There are investors who want to take an active role in prop­er­ty man­age­ment. If that is the case, then a DST would not be suit­able. Pas­sive own­er­ship with pro­fes­sion­al man­age­ment is a key ele­ment of ta DST.

§1031 Tax Deferred Exchange Eli­gi­bil­i­ty:

§1031 has been in exis­tence for over 100 years. Many investors have uti­lized this aspect of the Inter­nal Rev­enue Code. Investors can defer cap­i­tal gains tax­es on the sale of real estate that has appre­ci­at­ed in val­ue. Since 2004 DSTs were per­mit­ted to be used to sat­is­fy the1031 exchange prop­er­ty replace­ment require­ments.  Investors need to fol­low all the require­ments of the 1031 process to take advan­tage of the defer­ral ben­e­fits.

Delaware Statu­to­ry Trusts with a Pur­pose:

Diver­si­fi­ca­tion:

Diver­si­fi­ca­tion in and of itself does not elim­i­nate all risk. How­ev­er, investors are dis­cov­er­ing that DSTs, because of their low bar­ri­er to entry (typ­i­cal­ly $100,000) allow real estate investor to par­tic­i­pate in own­ing real estate. With a low­er bar­ri­er to entry an investor may be able to invest in dif­fer­ent asset class­es and geo­graph­ic loca­tion. The more real estate assets in a port­fo­lio may reduce the risk that may be asso­ci­at­ed with only one prop­er­ty or one geo­graph­ic loca­tion.

Estate Plan­ning:

Investors may not direct­ly ben­e­fit from estate plan­ning, but the heirs may ben­e­fit. Like oth­er assets the DST will be passed on to the heirs. This may be a seam­less trans­fer of wealth.  Some DST investors will struc­ture in their estate plan­ning giv­ing to char­i­ta­ble orga­ni­za­tion. Please con­sult your tax con­sul­tant for all the char­i­ta­ble giv­ing ben­e­fits that may min­i­mize tax­es.

Gen­er­a­tion of Income:

Indi­vid­u­als who are seek­ing pas­sive income from their invest­ment grav­i­tate to DST. Income dis­tri­b­u­tions typ­i­cal­ly are month­ly and pro­vide income from the under­ly­ing real estate asset.  Con­sis­tent cash flow con­tin­ues to be one of the major focus­es for many investors. There are a few DST that do not pro­vide cash flow by design. These DST are ref­er­enced as “Zero DSTs”,  (sim­i­lar to Zero Coupon Bonds).  All the income is uti­lized to pay down the loan on the prop­er­ty pro­vid­ing the investors with a build up of equi­ty and poten­tial large tax effi­cien­cies.

Con­clu­sion:

Real estate con­tin­ues to be a viable invest­ment tool in finan­cial plan­ning. Delaware Statu­to­ry Trusts are uti­lized by cash investors as well as 1031 investors.  DSTs are struc­tured as a  pass-through enti­ty sta­tus and ref­er­enced as frac­tion­al own­er­ship or ben­e­fi­cial inter­est struc­ture. This pro­vides many poten­tial tax ben­e­fits (please con­sult your tax con­sul­tant) The low bar­ri­er to entry ($100,000) enables many small­er investors the abil­i­ty to par­tic­i­pate in a pro­fes­sion­al­ly man­aged port­fo­lio of real estate.  

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.