Limitations on a DST Part 1 – The Seven Deadly Sins

In the domain of Delaware Statu­to­ry Trusts (DSTs), a fun­da­men­tal set of rules and guide­lines, referred to as the “Sev­en Dead­ly Sins,” delin­eates pro­hib­it­ed activ­i­ties and behav­iors that can have seri­ous con­se­quences for DST investors and spon­sors.

May 25, 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

The fol­low­ing is tak­en from a book writ­ten by the edi­tors of DSTNews.org coau­thored a new book called DST WEALTH BUILDING.

The Book is now avail­able at Ama­zon. The book is 470 pages and is a detailed guide on DSTs, §1031, §1033 and Oppor­tu­ni­ty Zones.  It was writ­ten for CPAs, Real Estate Pro­fes­sion­als and Accred­it­ed Investors. This was includ­ed in Chap­ter 12.

Under­stand­ing and adher­ing to these lim­i­ta­tions is para­mount for nav­i­gat­ing the com­plex­i­ties of DST invest­ing and mit­i­gat­ing poten­tial risks.

• Self-Deal­ing: The first dead­ly sin in DSTs per­tains to self-deal­ing, where a trustee or spon­sor engages in trans­ac­tions ben­e­fit­ing them­selves or relat­ed par­ties at the expense of the trust and its ben­e­fi­cia­ries. Exam­ples include pur­chas­ing prop­er­ty from the trust at below-mar­ket prices, charg­ing exces­sive fees, or favor­ing affil­i­at­ed enti­ties in con­tracts. Self-deal­ing con­tra­venes fidu­cia­ry duties, under­mines investor con­fi­dence, and can lead to legal reper­cus­sions, such as law­suits or reg­u­la­to­ry sanc­tions.
• Pro­hib­it­ed Trans­ac­tions: The sec­ond dead­ly sin involves engag­ing in pro­hib­it­ed trans­ac­tions that jeop­ar­dize the tax-deferred sta­tus of the DST. The IRS impos­es strict rules to main­tain this sta­tus, includ­ing lim­i­ta­tions on cer­tain types of trans­ac­tions or activ­i­ties. Exam­ples include invest­ing in dis­al­lowed assets, exceed­ing lever­age lim­its, or gen­er­at­ing unre­lat­ed busi­ness tax­able income (UBTI). Vio­lat­ing these rules can lead to dis­qual­i­fi­ca­tion of the DST’s tax-deferred sta­tus, expos­ing investors to imme­di­ate tax lia­bil­i­ties and penal­ties.
• Exces­sive Debt: Exces­sive debt, the third dead­ly sin, can pose risks for DST investors. While lever­age can enhance returns, too much debt increas­es finan­cial risk and may jeop­ar­dize DST sta­bil­i­ty. DSTs must adhere to strict debt-to-equi­ty ratios to main­tain tax advan­tages and avoid trig­ger­ing tax lia­bil­i­ties for investors. Exceed­ing these ratios can result in adverse con­se­quences, such as default risk or dimin­ished returns.
• Lack of Diver­si­fi­ca­tion: The lack of diver­si­fi­ca­tion, the fourth dead­ly sin, expos­es investors to height­ened risk by con­cen­trat­ing invest­ments in a sin­gle prop­er­ty or asset class. DST spon­sors have a fidu­cia­ry duty to diver­si­fy risk across mul­ti­ple prop­er­ties, mar­kets, and asset class­es. Fail­ing to do so can lead to dimin­ished returns, increased sus­cep­ti­bil­i­ty to mar­ket fluc­tu­a­tions, and poten­tial loss­es for investors
• Lack of Over­sight and Gov­er­nance: The fifth dead­ly sin is the absence of over­sight and gov­er­nance. Trustees and spon­sors must over­see trust oper­a­tions, ensure com­pli­ance with legal and reg­u­la­to­ry require­ments, and safe­guard ben­e­fi­cia­ry inter­ests. Insuf­fi­cient over­sight can lead to mis­man­age­ment, con­flicts of inter­est, and breach­es of fidu­cia­ry duty, erod­ing investor trust and poten­tial­ly result­ing in legal dis­putes.
• Non-Com­pli­ance with Secu­ri­ties Reg­u­la­tions: Non-com­pli­ance with secu­ri­ties reg­u­la­tions, the sixth dead­ly sin, is a seri­ous offense. The Secu­ri­ties and Exchange Com­mis­sion (SEC) impos­es strin­gent rules on DST inter­ests to pro­tect investors and main­tain mar­ket integri­ty. Fail­ure to com­ply can lead to civ­il and crim­i­nal penal­ties, reg­u­la­to­ry actions, and investor law­suits. DST spon­sors must ensure com­plete dis­clo­sure to investors, adhere to reg­is­tra­tion require­ments, and com­ply with anti-fraud pro­vi­sions to avoid legal lia­bil­i­ty.
• Breach of Fidu­cia­ry Duty: The final dead­ly sin involves a breach of fidu­cia­ry duty by trustees and spon­sors. Fidu­cia­ries owe loy­al­ty, care, and obe­di­ence to the trust and its ben­e­fi­cia­ries. Breach­es, such as self-deal­ing or neg­li­gence, can result in legal lia­bil­i­ty, finan­cial loss­es, and rep­u­ta­tion­al dam­age. Trustees and spon­sors must act pru­dent­ly, hon­est­ly, and in good faith to ful­fill their duties and pro­tect investor inter­ests.

The “Sev­en Dead­ly Sins” serve as a cau­tion­ary frame­work for DST investors and spon­sors, high­light­ing poten­tial pit­falls and risks. By under­stand­ing and avoid­ing these sins, investors can safe­guard their invest­ments, pro­tect their inter­ests, and max­i­mize the ben­e­fits of DST own­er­ship.

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.

Thank you.