Business Succession Plans Utilizing DSTs

Busi­ness own­ers have start­ed to iden­ti­fy Delaware Statu­to­ry Trust (DST) as a poten­tial alter­na­tive in their busi­ness suc­ces­sion. As a Cer­ti­fied Exit Plan­ning Advi­sor (CEPA) we enter­tain a vari­ety of ques­tions regard­ing how inclu­sion of a DST may pro­vide an added ele­ment or option for busi­ness own­ers.

July 15, 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

When exit­ing a busi­ness, the plan­ning may start years ahead of the desired time as com­pared to sell­ing just the real estate. There are also tools used to ana­lyze a sale lease back in the last years of own­ing the busi­ness real estate. 

There is always a quest to iden­ti­fy addi­tion­al strate­gic tools in the suc­ces­sion plan for busi­ness­es. The option of Delaware Statu­to­ry Trusts (DSTs) has become part of the dis­cus­sion.  Busi­ness own­ers may typ­i­cal­ly seek a smooth tran­si­tion of their busi­ness own­er­ship.  This may be to a fam­i­ly mem­ber (30% of the time) or out­side enti­ty as a new buy­er. When there is real estate involved in the busi­ness includ­ing real estate heavy busi­ness­es the DSTs may offer unique advan­tages.  Let’s dive into poten­tial rea­sons for includ­ing DST in the suc­ces­sion due dili­gence.

Delaware Statu­to­ry Trust (DST) Quick Review

An enti­ty called a Delaware Statu­to­ry Trust is a legal­ly rec­og­nized trust per­mit­ting indi­vid­ual unre­lat­ed investors to own a frac­tion­al inter­est in a prop­er­ty. The own­er­ship may be in a sin­gle prop­er­ty or a port­fo­lio of prop­er­ties. There are tax advan­tages, flex­i­bil­i­ty of own­er­ship along with ease of man­age­ment with a DST.  DSTs have become a pop­u­lar invest­ment with cash investors as well as 1031 exchange investors.  For most of our dis­cus­sion we will focus on DSTs that are already pack­aged and offered by an insti­tu­tion­al spon­sor. It is pos­si­ble for indi­vid­u­als to estab­lish their DST. How­ev­er, the cost involved may be pro­hib­i­tive to most busi­ness own­ers.

Busi­ness Suc­ces­sion Plan­ning Key Ben­e­fits of Using DSTs

1. Tax Advan­tages:
   • §1031 Exchange Eli­gi­bil­i­ty: If the busi­ness own­er is sell­ing real estate owned by the busi­ness (under con­trol of the busi­ness own­er) the DST can sat­is­fy the IRS replace­ment prop­er­ty require­ment under the 1031 exchange. This enables the busi­ness own­ers to defer cap­i­tal gains tax­es on the appre­ci­a­tion of real estate. The prop­er­ty is sold, and the pro­ceeds may be invest­ed into one or more DSTs. Busi­ness own­ers may diver­si­fy the replace­ment prop­er­ties with dif­fer­ent asset class­es and geo­graph­ic areas.
   • Tax Defer­ral: each busi­ness own­er (investor) has dif­fer­ent needs as well as risk tol­er­ances. Under­stand­ing the defer­ral (not elim­i­na­tion) of cap­i­tal gains is a key ele­ment of the exchange.  Defer­ring cap­i­tal gains also enables investors to have more cap­i­tal at work with the defer­ral of cap­i­tal gains. Busi­ness own­ers who are devel­op­ing a suc­ces­sion plan that pro­vides gen­er­a­tional wealth will also be con­fi­dent that there will be a step up in basis at some point in time.
2. Pas­sive Income Stream:
   • Many busi­ness own­ers who are posi­tioned to sell (poten­tial­ly baby boomers) may be seek­ing a more pas­sive income stream. Accred­it­ed busi­ness own­ers when invest­ing in a DST typ­i­cal­ly review month dis­tri­b­u­tions from the invest­ment. me gen­er­at­ed from the DST can replace the busi­ness income, pro­vid­ing finan­cial sta­bil­i­ty.
3. Sim­pli­fied Man­age­ment:
   • Feed­back from many busi­ness own­ers focus­es on seek­ing a sim­pler day to day man­age­ment respon­si­bil­i­ty. The struc­ture of the DSTs relieves the busi­ness own­er from any man­age­ment respon­si­bil­i­ty. This may be key for the busi­ness own­er to devel­op a suc­cess­ful plan when the next gen­er­a­tion may not have the desire, skills, knowl­edge or inter­est in tak­ing over the busi­ness. The busi­ness own­er may not want to keep a prop­er­ty where the job descrip­tion may include tak­ing care of ten­ants, toi­lets and trash.
4. Shared or Frac­tion­al Own­er­ship:
   • When it comes time for the DST to be sold or passed on to heirs the dis­tri­b­u­tion may be eas­i­er than a sin­gle prop­er­ty.  Hav­ing mul­ti­ple DST in a port­fo­lio may pro­vide for an equi­table dis­tri­b­u­tion of the busi­ness assets that are not invest­ed in DSTs.
5. Diver­si­fi­ca­tion:
   • Sell­ing the real estate the busi­ness owned and invest­ing into sev­er­al DST (asset class­es and/or geo­graph­ic regions) may diver­si­fied the risk of own­ing any real estate. Many busi­ness own­ers are seek­ing finan­cial sta­bil­i­ty in their suc­ces­sion plan.

Busi­ness Suc­ces­sion Appli­ca­tion of DSTs

1. Sell­ing the Busi­ness to a Third Par­ties:
   • When and if the busi­ness is offered for sale and there is real estate involved it is not too ear­ly to con­tem­plate the exit strat­e­gy. The pro­ceeds may be invest­ed in a DST (via 1031 exchange). The orig­i­nal busi­ness enti­ty can defer cap­i­tal gains. If the busi­ness is owned by a group there may be a few oth­er steps involved.  See pre­vi­ous arti­cle on drop and swap.
2. Estate Plan­ning:
   • Estate plans may be very com­plex, and each investor should seek their own team of experts for advice. A broad range of strate­gies may include DSTs. If assets are in a DST, it may be eas­i­er to man­age and pass on to heirs.  In addi­tion, there would be a step up in basis upon the pass­ing to the heirs as will all rea estate.

Cost, Risk & Con­sid­er­a­tions

1. Com­plex­i­ty and Costs:
   • For the indi­vid­ual busi­ness own­er set­ting up a DST typ­i­cal­ly is not fea­si­ble. Unless the poten­tial real estate and future estate is worth mil­lions of dol­lars, we have now seen this in prac­tice.  DST estab­lished by spon­sors typ­i­cal­ly may be over the $25 Mil­lion mark and goes to $200 Mil­lion plus in a spon­sor offer­ing. There are ongo­ing trustee and man­age­ment fees as well.
2. Reg­u­la­to­ry Com­pli­ance:
   • The paper­work involved with a DST typ­i­cal­ly involves a high­ly spe­cial­ized legal team.  Nor­mal­ly these offer­ings are a Reg­u­la­tions D offer­ing and either a 506 (b) or 506 © offer­ing. When acquir­ing from a spon­sor the investor needs to be an accred­it­ed investor.
3. Liq­uid­i­ty Issues:
   • There are many ben­e­fits of a DST. How­ev­er, one of the draw­backs is the lack of liq­uid­i­ty. This lack of liq­uid­i­ty may make it ide­al for estate plan­ning.  If the investor needs cash at spe­cif­ic times this may be an issue.  The suit­abil­i­ty sur­vey most finan­cial advi­sors’ skill in this field will review pro­gram options and exit strate­gies.

Con­clu­sion

There are sev­er­al effi­cient strate­gies for busi­ness own­ers to review. The Delaware Statu­to­ry Trust may be a ver­sa­tile tool espe­cial­ly when sell­ing real estate asso­ci­at­ed with the busi­ness. Busi­ness own­ers seek­ing tax defer­ral, tax favored pas­sive income and poten­tial cap­i­tal appre­ci­a­tion are now includ­ing DST in the dis­cus­sion. DST are a spe­cial­ized prod­uct offer­ing and not every­one has the cre­den­tials to ade­quate­ly review the fea­tures and ben­e­fits of each pro­gram. The goal for the finan­cial advi­sor is to work hand in hand with the busi­ness own­er to iden­ti­ty pos­si­ble strate­gies.

This is for infor­ma­tion­al pur­pos­es only, does not con­sti­tute indi­vid­ual invest­ment advice, and should not be relied upon as tax or legal advice. Please con­sult the appro­pri­ate pro­fes­sion­al regard­ing your indi­vid­ual circumstance(s).

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.