Current tax laws make the Delaware Statutory Trust (DST) the preferred structure to purchase management-free real estate through a 1031 Exchange. Real estate investors looking to get out of management and still maintain the tax deferral benefits of a 1031 should consider DSTs. DST properties offer benefits that other types of properties do not, including lower minimum investment amounts, diversification, ease of financing, and potentially better cash flow and appreciation.   

This brochure provides a basic description of the DST and how it works with a 1031 Exchange. For a more thorough analysis, description, and a list of DST offerings, please contact us.   

What is a DST?

A DST is a legal trust created under Delaware law in which each investor owns a beneficial interest. For federal income tax purposes, each investor is treated as owning an undivided fractional interest in the property.

DSTs qualify as replacement properties for 1031 Exchanges under IRS Revenue Ruling 2004-86. While the DST has been around for decades, it was not until 2004, when the IRS issued the revenue ruling, that DSTs were used for 1031 purposes. Since that time, demand for DSTs has skyrocketed as more real estate investors realize their benefits.    

How Do Delaware Statutory Trusts Work?

A real estate company, known as a sponsor, purchases a particular property structured under a newly formed DST. The properties purchased are typically large institutional grade properties that most individual real estate investors would be unable to purchase on their own. A broad range of asset types are purchased under a DST including apartment complexes, office buildings, NNN properties, self-storage, medical office, industrial buildings, and even golf courses. Even though this legal trust was created in, and has the state of Delaware in the title, property can be purchased in California and all across the nation.

Once the property is purchased, interests in the DST are offered to investors and sold through secondary escrow closings once a week until all the equity in the DST is sold.  

Investors are paid cash flow distributions each month based on their ownership interest. For example, if an investor purchases 1.237% of the DST, they receive 1.237% of the net cash flow generated by the property. Quarterly reports keep the investors updated on the property. Each year, the sponsor provides the investors with a Year End Operating Statement that lists the information necessary for the investors to report their income and deductions from the operations of their property. This statement also details valuation for investors to depreciate their property and offset their taxes.  

DSTs are purchased with the intent to sell in the future for a profit. On average, DSTs are sold seven years after purchase, but the holding period varies by property and market conditions. Once the property sells, each investor receives their proportionate share of the net sales proceeds. Using our previous example, an investor that purchased 1.237% of a DST will receive 1.237% of the net sales proceeds. Investors can choose to take the sales proceeds in cash or complete another 1031 exchange to continue to defer their taxes. 

What are the Benefits?

• Management Free.  DST properties are managed by professional in-place management companies with a vested interest in the successful performance of the property. DST investors no longer need to deal with the “5 T’s” of real estate ownership: tenants, toilets, trash, telephone calls, and time commitments.  The day-to-day supervision of the property is handled by an experienced real estate company with the staff and the necessary resources to provide better and more efficient management.

• Potentially Higher Cash Flow and Appreciation.  DSTs tend to benefit from the economies of scale associated with larger institutional type properties. DST sponsors, due to their financial strength, negotiating power, and high purchase volume, frequently purchase properties with better terms and financing than those available to individual buyers. Due to these factors, in conjunction with professional management, DSTs may provide investors with better cash flow and appreciation, depending on the type of property, than properties they could purchase on their own.  

• Diversification.  Diversification is a prudent investment goal, but purchasing a commercial property requires a substantial amount of equity, forcing real estate investors to put a lot of their “eggs in one basket.” DSTs offer a solution to this problem because they can be purchased for as little as $100,000.  Even smaller exchanges can be diversified. For example, an investor with a $360,000 exchange could purchase three DSTs (by investing $120,000 into each property) in different locations and asset types across the country.

• No closing risks.  IRS Code 1031 imposes strict time deadlines to complete an Exchange: 45 days to identify replacement properties and 180 days to close. Many exchanges fail because investors are unable to find and close on replacement properties in time. Because DSTs are already purchased by the trust, there are no closing risks. Investors can close on their DST replacement properties within a week after selecting their property and well within the 1031 exchange deadlines.

• No Loan issues.  For a 1031 exchange, any debt on sold property needs to be replaced with equal or greater debt on the replacement property. Often, investors find it difficult to obtain financing to replace their debt.  DSTs solve this problem by making the trust, not the investor, the borrower. There are no loan documents for the investors to sign or a pre-qualification to pass. Although the investor is not liable or even a party to the loan, the debt on the DST qualifies as replacement debt for the investor’s exchange.  

• Asset protection.  The DST is a bankruptcy remote entity, meaning that it prevents the investor’s creditors from seizing the property and protecting the investor from liability related to the property.