Real Estate Investment with DSTs: Exploring how DSTs are commonly used for Real Estate Investments.

More and more investors who own real estate are review­ing the advan­tages Delaware Statu­to­ry Trusts (DSTs) may pro­vide. Many investors are curi­ous as to how DSTs may be uti­lized in a Sec­tion 1031 tax deferred exchange. This arti­cle may pro­vide an overview of investors’ advan­tages.

March 4, 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

IRC Sec­tion 1031 Exchanges:
Investors typ­i­cal­ly will seek meth­ods to elim­i­nate tax­es, reduce tax­es or at least defer tax­es for some peri­od of time. Investors who own real estate that has appre­ci­at­ed dur­ing their own­er­ship or hold­ing peri­od will look to an IRC §1031 tax deferred exchange for the defer­ral of cap­i­tal gains tax­es to a lat­er time.  This is a defer­ral not an elim­i­na­tion of tax­es. The appre­ci­at­ed real estate does not include a pri­ma­ry res­i­dence. For twen­ty years DSTs have been uti­lized for a §1031 exchange. Mean­ing a DST will qual­i­fy as a replace­ment prop­er­ty if the investor fol­lows all the require­ments of the exchange process.

Move from Active to Pas­sive Invest­ment Struc­ture:
The struc­ture of the DST pro­vides lim­it­ed involve­ment. Active Investors who enjoy being involved in the dai­ly man­age­ment of the invest­ment real estate are not typ­i­cal­ly a DST investor. The Pas­sive struc­ture of the DST pro­vides for the investors to have a ben­e­fi­cial own­er­ship inter­est in the Trust. The trust man­ages the prop­er­ty.  Investors seek­ing a move from active man­age­ment to pas­sive man­age­ment appre­ci­ate the hands-off approach.

Frac­tion­al Own­er­ship:
There are sev­er­al types of Frac­tion­al Inter­ests that qual­i­fy for a 1031 exchange. The trust pro­vides for a frac­tion­al (aka ben­e­fi­cial) inter­est to be assigned to indi­vid­ual investors. There is the poten­tial for diver­si­fi­ca­tion for the investors because of the low­er invest­ment lev­els (typ­i­cal­ly $100,000) which may per­mit the investors to allo­cate invest­ment dol­lars (equi­ty) into sev­er­al DST. This may be sev­er­al prop­er­ties with­out the need to man­age any of the prop­er­ties.

Pro­fes­sion­al Man­age­ment:
The DST is man­aged by a Trustee.  The spon­sor of the DST will appoint a trustee who is respon­si­ble for the man­age­ment of the DST. All the deci­sions for the day-to-day oper­a­tions as well as man­ag­ing the prop­er­ty is del­e­gat­ed to the trustee. Investors may not have the qual­i­fi­ca­tion (or time) to man­age the larg­er insti­tu­tion­al style prop­er­ties (assets) that is required.  

Insti­tu­tion­al grade Large Prop­er­ties:
The DST pro­vides indi­vid­ual investors access to Larg­er insti­tu­tion­al grade prop­er­ties (Assets). When investors pool their equi­ty togeth­er with oth­er investors this enables the abil­i­ty to acquire larg­er prop­er­ties. Many of the DST prop­er­ties are typ­i­cal­ly out­side the reach of an indi­vid­ual investor.

Mit­i­ga­tion of Risk:
there is no guar­an­tee that Diver­si­fi­ca­tion will elim­i­nate all risk. How­ev­er, the DST struc­ture (again low­er bar­ri­er to invest­ing) allows the investors to deploy cap­i­tal across sev­er­al prop­er­ties. This may be dif­fer­ent geo­graph­i­cal loca­tion or asset class­es. The loca­tions may be Flori­da, Ten­nessee, Texas and oth­er states.  Asset class­es may be mul­ti­fam­i­ly, indus­tri­al or self-stor­age, etc. This diver­si­fi­ca­tion tends to mit­i­gate the risk of hav­ing all cash invest­ed in one loca­tion or one prop­er­ty.

Sta­ble Income:
One of the main rea­son investors have grav­i­tat­ed toward DST is the Cash Flow.  There are only a few DST that do not pro­vide a month­ly dis­tri­b­u­tion.  The income is gen­er­at­ed by the rental income the ten­ants or users of the DSTs prop­er­ty pays to the Trust. The investors receive a share of the income based on their frac­tion­al inter­est per­cent­age in the DST. The DSTs that do not pro­vide dis­tri­b­u­tion are by design and may pro­vide tax advan­tages for investors who do not need or require month­ly cash flows.

Lim­it­ed Lia­bil­i­ty:
Investors seek­ing Asset Pro­tec­tion enjoy the addi­tion­al struc­tur­al ben­e­fits of the DST. There are oth­er legal enti­ties (lim­it­ed lia­bil­i­ty Com­pa­nies LLC) that offer pro­tec­tion to investors.  DST offers investors lim­it­ed lia­bil­i­ty pro­tec­tion.  What this means is the investors’ oth­er per­son­al assets are pro­tect­ed from any poten­tial lia­bil­i­ty asso­ci­at­ed with the trust real estate prop­er­ty or asset.

Defined Invest­ment Peri­od:
There is a stat­ed or defined time frame for the life of the DST. The pri­vate place­ment mem­o­ran­dums (PPMs) will typ­i­cal­ly have a time frame expressed as “max­i­mum life” and “expect­ed life”. The expect­ed life sim­ply means or reflects when the spon­sor antic­i­pates the DST being sold.  Any sale of the DST must sat­is­fy the finan­cial require­ments and be in the best inter­est of the investors. The §1031 exchange require­ments also have a safe har­bor or hold­ing peri­od.

Trans­fer­abil­i­ty:
If an investor leaves their DST to an heir (when they pass away) there would be a step up in basis to cur­rent mar­ket val­u­a­tion.  This would elim­i­nate the pay­ment of any cap­i­tal gains tax­es. Cur­rent­ly there is a lim­it­ed Sec­ondary Mar­ket for an investor to sell their DST. How­ev­er, the ben­e­fi­cial inter­est or frac­tion­al inter­est may be trans­ferred sub­ject to restric­tion. While there may be some liq­uid­i­ty pro­vid­ed to the investor, we spend time review­ing the suit­abil­i­ty of all alter­na­tive invest­ments with each investor.

Each investor must receive a PPM and we encour­aged all prospec­tive investors to review the PPM and under­stand the com­po­nents of the DST.  This would include the under­ly­ing prop­er­ty, mar­ket dynam­ics, the spon­sor strat­e­gy for the prop­er­ty as well as the fee struc­ture and dis­tri­b­u­tion tar­gets. Please con­sult your tax pro­fes­sion­al.  We work with investors to deter­mine first if the DST or even the §1031 is a suit­able strat­e­gy. Investors’ goals as well as risk assess­ment are part of our com­pli­men­ta­ry con­sul­ta­tion.

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.