A Delaware Statutory Trust (commonly referred to as a DST) is, as the name suggests, a legal entity created as a trust under Delaware state law. A DST is created for real estate investment purposes, and is especially useful in a 1031 exchange.
Under a DST, investors each own a pro rata share of the DST itself. The DST in turn holds title to various real estate interests, and distributes any income received from the properties (either through rental income or the sale of the property) to the investors in proportion to their ownership share in the DST.
The DST, via its signatory trustee, makes all decisions related to any property held by the trust, freeing up investors from this responsibility. One important thing to note about a DST is that the trust is not considered a taxable entity, so any profits or losses are passed through to the investors of the trust.
When it comes to 1031 exchanges, the IRS has determined that any beneficial interest in the DST is treated as identical to a direct interest in real estate. This means that DST-held properties fully qualify for 1031 exchanges, so long as the other requirements of such an exchange are also met.
For investors not looking for the responsibility of day-to-day management and decision-making authority related to real estate holdings, a DST may be an excellent choice.
Benefits of a DST
One of the main reasons investors are so interested in purchasing an interest in a DST is the benefit of owning securitized real estate. However, a DST provides other benefits to investors, as well.
Eliminates Unanimous Approval Requirement
Unlike a Tenancy-In-Common (TIC) ownership structure, a DST does not require the unanimous approval of all the investors to make decisions related to the held real estate. For example, should the economic environment require the quick sale of a parcel of real estate held by the DST, the decision-making authority to list or sell the property lies with the signatory trustee of the DST rather than the investors themselves.
Limited Personal Liability
Because of the “bankruptcy-remote” provision of every DST, individual investors enjoy limited liability as to their personal assets. Should the DST fail and enter bankruptcy, the most at risk for any individual investor is his or her investment in the trust. Creditors of the trust are limited from reaching any other assets of any investor.
For purposes of financing purchases by the DST, lenders treat the DST as a single borrower (rather than scrutinizing each and every individual investor). This makes financing easier and less expensive to obtain. Likewise, because the individual investor is not subject to a credit screening, his or her individual credit rating is not impacted by participation in a DST.
Loan Carve-Out Requirements Eliminated
Since a DST investor’s rights are limited to only receiving distributions and the investor has no voting authority related to day-to-day operations, investor fraud carve-outs are eliminated for the individual investors. Any lender will only look to the signatory trustee or sponsor for these carve-out provisions.
Lower Minimum Investment
A DST is allowed up to 499 individual investors, which allows the minimum investment amounts to be much lower than with a TIC (which only allows up to 35). This lets investors with less to invest to still participate in a shared-ownership strategy for real estate investments.
Risks of a DST
A DST offers an investor many benefits not found in other shared-ownership types of real estate investments. However, DSTs do not come without some risk – just like any other investment.
One of the biggest risks to consider is the reliance on a program sponsor to manage the investment. Unlike a Tenancy-In-Common (TIC) where individual investors have a direct say, investors in a DST relinquish the day-to-day decision making authority to the program sponsor. This means that should the program sponsor make unwise decisions or become insolvent, the DST could fail without any meaningful input from the individual investors.
Also, as with any investment, there are tax-related risks associated with using a DST for purposes of a 1031 exchange. While DSTs are often ideal for this purpose, there are no guarantees when it comes to the IRS. There is always a chance that the IRS will not approve the DST structure or a particular 1031 exchange.
While the benefits of a DST tend to outweigh the risks, it is prudent to have a full understanding of both when deciding whether to participate in a DST.