In the past few years, Delaware Statutory Trusts (“DSTs”) have become increasingly more prevalent among the real estate investor community, primarily because a DST is an entity that qualifies as “like-kind” real estate for the purposes of a 1031 exchange. In other words, investors can direct the proceeds from the sale of their relinquished property towards purchasing a beneficial interest in a DST.
DSTs can be an effective tool for maintaining wealth as they help investors defer tax from the sale of a real estate asset, realizing immediate and significant tax savings. However, like all real estate related investments (and even more so with those that carry special deferral tax benefits), DSTs come with both risks and rewards – their pros and cons.
One of the greatest advantages of a DST is the savings in capital gains tax for the investor and estate beneficiaries. But the structure brings many other benefits as well, including flexibility.
DSTs will often provide flexibility with regard to the debt replacement component, via guarantees or other unique mechanisms. A recent trend with DSTs has been linking them with an UpREIT structure (typically via an upfront acquisition option), which can provide for more flexibility as it pertains to an eventual taxable exit controlled by the investor.
DSTs also offer lower minimum investments, limited investor liability, risk diversification and greater income potential through access to institutional-quality assets. Furthermore, an investment into a DST would result in significantly less time commitment & administrative duties for a formerly active investor/family.
With these benefits come limitations that should be considered in light of the investor’s wealth strategies and goals.
Unlike equities, DSTs are considerably less liquid. DSTs are part of a fractional beneficial interest in a trust that owns a large piece of illiquid real estate, and investors should be able and willing to hold their investment in a DST 1031 property for the full life of the program, which may last for a decade or more. Secondary markets do exist for DST investments, but even these are quite illiquid and there is never a guarantee that an investor will be able to find a buyer for a reasonable price.
It is important to note that a DST is a purely passive management structure that comes with several unique restrictions. No additional contributions can be made after the DST offering closes. The trustee cannot renegotiate existing debt terms or enter into a new lease. Cash retained by the trustee for reserves can only be invested in short-term debt obligations. These are just a few of the considerations that investors should make when deciding if a DST is the right investment strategy for them.
As DSTs gain even more prevalence in the market, it may be the right option for use as a 1031 replacement strategy. Before investing into a DST, whether as a means of closing your 1031 exchange or for simple real estate investment purposes, investors should discuss any specific tax requirements and investment goals with their tax and wealth advisors, as the rules regarding 1031 exchanges, in particular, are very complex. Prospective investors should also carefully read the DST offering’s Private Placement Memorandum for the complete business plan and other risk factors.
Grassi’s Real Estate advisors are an excellent resource of knowledge and insight into DSTs, 1031 exchanges and other real estate investment strategies. Contact your Grassi advisor or Evan Fox, Real Estate Tax Leader, to learn more.