Investors in a Delaware Statutory Trust (DST) are considered beneficial owners or beneficiaries. Under the DST structure there would be a distribution of income generated from the underlying real estate.
March 10, 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
In addition, if there are profits from the sale of the DST then beneficial owners would share in those profits based on their proportionate share of ownership. Understanding how potential distribution will be structured is a key element of due diligence.
Pass-Through Entity:
The Trust does not pay taxes on the income collected from any of the investments. DSTs are considered a pass-through entity for tax purposes. The individual beneficiaries will receive distribution of income, gains on the sale of the property (if any), deductions for depreciation and interest payments on any loan (if applicable).
Rental Income:
DSTs assets may be multifamily, student housing, industrial, self-storage, etc. Many and almost all DST are structured with income to be distributed. The primary source of cash flow in generated from the underlying real estate.
Distribution Frequency:
The Private Placement Memorandum (PPM) will state when the proposed distribution will be sent to the beneficiaries. Most distributions are sent to the beneficiary designated account via ACH. These distributions are sent often monthly or quarterly.
Proportional Distribution:
Investors own a fractional interest in the DST and are considered beneficial owner and have a proportional share of ownership. The ownership percentage is determined on the amount of cash (capital) the individual investor contributes to the DST Trust.
Priority Distributions:
Each DST (with a underlying real estate asset) may have expenses that the Trustee will need to pay from the tenant income. These obligations will also be stated in the PPM and include a variety of operating expenses, potentially debt service on any loans on the property, taxes, and other potential expenses. These expenses are paid prior to any distribution to the beneficial owners. Triple Net Lease arrangement (where the tenant pays all the building expenses) may provide for a high distribution to the beneficial owners.
Return of Capital:
When the property is sold (as determined by the sponsor) there may be a distribution from the sale. The distribution may be a combination of return of capital and potentially profits from the sale. The return of capital may not be considered a taxable event (unless the investment was a 1031 exchange). The proceeds of the sale would be considered a capital gains event. Many investors will investigate utilizing a 1031 exchange.
Reserves and Contingencies:
The PPM will disclose the funds needed for any property improvements, any capital expenditures as well as any reserve and contingency funding. This is very important since the DST is not able to reaise additional capital once the DST is in place. The trustee needs to ensure the DST has sufficient funds to maintain the property.
Tax Implications:
One of the tax benefits DST investors enjoy is the pass through structure of the DST. The beneficial owners may utilize deduction on their individual returns for losses, depreciations, gains, losses that flow through to their individual returns. The same tax advantages of traditional real estate apply to DSTs.
Distribution Waterfall:
The PPM may outline a distribution of income above a base rent typically found in a proforma in the PPM. There may be a sharing of rents above the base rent called bonus rent. The bonus rent may be shared in some type of split between the master tenant (for performance) and the investors. Upon the sale there may also be a waterfall of profitability in some structures. Certain cost of sale items such as paying off outstanding mortgage or other expenses would be paid and then a distribution to the investors.
Secondary Market Considerations:
There are limited secondary markets for the sale of a DST. For this reason, investors need to understand that DST are considered an illiquid investment. There may be options for investors to sell their beneficial interest in the DST prior to the Trustee initiating a sale. However, certain restrictions may affect the sale.
Conclusion:
DSTs require that the PPM is provided to prospective investors. This includes all the offering documents regarding the DST. Consulting a financial advisor who understands the structure and function of the DST as well as the 1031 exchange is strongly encouraged.
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.
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