A Delaware Statutory Trust, known as a DST, is a business trust created under Delaware law.1 On August 16, 2004, the Internal Revenue Service issued Revenue Ruling 2004-86 which permitted DSTs to qualify as replacement properties as part of an property owner’s 1031 exchange transaction.2
The ruling has made DSTs a popular investment for property owners who are interested in the potential tax deferral provided through a 1031 exchange but who would prefer a more passive investment.
A DST investment typically appeals to property owners looking for steady income and a passive approach to their realestate investments. Often times, property owners who are selling a property are faced not only with a significant tax bill, but also the added burden of locating, purchasing and managing a new property. With an investment in a DST, those property owners may still reap the potential tax benefits of a 1031 exchange while eliminating the often cumbersome process of purchasing and owning a new property.
Due to some of the operational restrictions set forth in the DST structure, the investments tend to include buildings with long-term leases in place and/or steady and predictable cash flows. Further, DSTs may offer property owners a chance to invest in professionally managed, potentially high-quality properties.
In short, property owners in a DST are pooling their money to acquire property(s) that they normally could not afford on their own. If the DST investment is liquidated, the property owners have the option to pay any associated taxes or to continue their tax-deferral strategy via a direct 1031 exchange or by investing into another DST offering.
A real estate sponsor firm establishes a DST and the DST acquires a property or multiple properties. Once the DST has been created by the real estate sponsor firm, property owners may purchase beneficial interests in the DST. The property owner looking to invest in a DST would identify the underlying property(s) of the DST and their beneficial interest in the DST as part of the replacement property process and instruct their Qualified Intermediary to make the investment on their behalf.
Depending on the type of property and the underlying leases in place, the real estate sponsor may enter into a master lease with the DST whereby an entity created by the real estate sponsor is the lessee and the DST is the lessor. Under this construction, the lessee (or sponsor) is responsible for operating the property and agrees to pay the DST a predetermined rent payment derived from potential income generated by the underlying property(s). Each property owner receives their proportionate share of any potential lease cash flows paid to the DST, based on their beneficial interest in the DST.
A DST aims to provide a turnkey passive real estate investment with steady and predictable income. These investments may be done as a direct investment or as part of the 1031 exchange process. Both strategies provide a potential added tax-deferral benefit to investors.
Like any tax-deferral strategy, property owners should understand the benefits and drawbacks of the various options and should work alongside their attorneys, accountants, tax counsel and financial advisors.
The information contained herein is intended for informational purposes only and does not constitute legal, tax, or accounting advice or any other advice of any kind. Information contained herein relates to general market information and/or general firm business information and does not constitute an offer to sell or a solicitation of an offer to buy any security and may not be relied upon in connection with the purchase or sale of any security. If any offer of securities is made, it shall be made pursuant to a formal offering which will contain material information not contained herein and that will supersede, amend and supplement this information in its entirety.
It is important to note that although 1031 exchanges may be appropriate for some, it may not be appropriate for others. Property owners should consult with their attorneys, tax counsel, financial advisors and other professionals regarding the applicability of 1031 exchanges to your current situation.
Please note, this piece contains broad market commentary regarding a specific point in time, is subject to change without notice, and should not be considered blanket advice or advice of any kind – each property owners’ situation is different and should be evaluated on an individual basis prior to determining whether or not a 1031 exchange is appropriate. Certain of the economic and market information contained herein has been obtained from published sources and/or prepared by third parties. While such sources are believed to be reliable, Platform Ventures and its affiliates, employees and representatives do not assume any responsibility for the accuracy of such information and have no obligation to verify its accuracy.