Investing in Delaware Statutory Trusts
Taxpayers who are selling real estate in a 1031 exchange know that they must buy real estate for their exchange to be an exchange of “like-kind” properties. For most people, this means buying a fee simple interest in real estate. There is another product, however, that can qualify for a 1031 exchange despite the fact that the taxpayer buys an interest in an entity rather than acquiring real estate directly. This is known as a Delaware Statutory Trust (DST).
What is a DST? A DST investment is typically a real estate investment that is held in a special entity called a Delaware statutory trust. DSTs must be structured properly to meet the IRS requirements set out in a ruling issued by the IRS (Revenue Ruling 2004-86). Provided the DST is structured properly, the taxpayer can acquire an interest in the DST and it is just like buying a piece of real estate directly. Each owner owns a beneficial interest in the DST, and the DST owns one or more properties.
What makes DSTs somewhat different from purchasing property through a standard real estate transaction is that they are generally sold as securities, which requires that an investor work with a securities representative rather than a real estate professional.
Advantages of Owning a DST
Some investors find purchasing these interests beneficial because they can purchase a small interest in larger assets which they could not buy on their own, and they can more easily diversify their investments by purchasing multiple DST interests. They can also avoid management requirements, since the DST providers handle the management of the property.
Taxpayers can also sometimes use a DST when they have a small balance of exchange funds left over after having acquired a replacement property. For example, if you sell a property for $1,500,000 and buy a property for $1,200,000 it may be difficult to find another property on which to spend the $300,000 balance. In some cases you could acquire a DST interest for $300,000 to use up all of your money and defer all of the gain.
Disadvantages of Owning a DST
For some investors, the lack of control over the DST asset in which they have invested is a reason not to invest in DSTs. What if the taxpayer wants to sell his interest in the DST at some point in the future? Although that should work from a 1031 perspective, is there a secondary market where the taxpayer can dispose of the DST interest? Investors should also carefully consider whether the investment itself is appropriate for them. Although a DST is an alternative to a standard replacement property acquisition, it may not fit every taxpayer’s needs. Taxpayers should consult with their legal counsel, tax professional and financial advisor prior to moving forward in this type of transaction.
Please note that this article is for informational purposes only, and First American Exchange is not endorsing any investment or product.
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