A Delaware Statutory Trust (DST) is a legally recognized trust formed under the Delaware Statutory Trust Act1. It allows for the fractional ownership of investment property and offers a unique blend of tax advantages, operational efficiency, and investment flexibility. This report provides a comprehensive analysis of DSTs, exploring their mechanics, benefits, drawbacks, and suitability for different investor profiles.
What is a Delaware Statutory Trust (DST)?
A DST is a separate legal entity that holds title to real estate assets1. Investors acquire a "beneficial interest" in the DST, representing their fractional ownership in the underlying property2.
The DST structure allows investors to participate in institutional-quality assets, such as large apartment complexes, office buildings, or shopping malls, with a comparatively low minimum investment2. A key feature of DSTs is their passive ownership structure3. A professional real estate company, known as the "DST sponsor," manages the property on behalf of the investors2. This eliminates the burdens of direct property management, such as tenant relations, property maintenance, and rent collection.
DSTs are distinguished as separate legal entities from their trustees and beneficial owners4. This helps to provide limited liability to beneficial owners, protecting them from the liabilities of other owners and the liabilities of the DST itself.
Pros and Cons of DSTs
Pros | Cons |
Tax Benefits: DSTs are structured to qualify for 1031 exchanges, allowing investors to defer capital gains taxes on the sale of relinquished property5. This can result in significant tax savings, especially for those in high tax brackets. | Illiquidity: DSTs are illiquid investments with no readily available secondary market6. Investors may face challenges if they need to liquidate their investment before the DST's planned holding period. |
Passive Income: DSTs generate passive income streams from rental payments and potential property appreciation3. Investors receive distributions without the responsibilities of active property management. However, there are no guarantees for monthly distribution amounts or projected appreciation7. | Lack of Control: Investors have no control over the property's management or operational decisions8. They rely on the DST sponsor's expertise and fiduciary responsibility. |
Diversification: DSTs allow investors to diversify their real estate holdings by investing in multiple properties across different asset classes and geographic locations3. | Potential for Loss: Like any real estate investment, DSTs carry inherent risks, including market fluctuations, property damage, and tenant vacancies9. Investors could potentially lose their entire principal investment. |
Access to Institutional-Quality Assets: DSTs provide access to large-scale, professionally managed properties that may be otherwise unattainable for individual investors2. | Fees: DSTs typically involve fees associated with acquisition, syndication, ongoing management, and disposition of the property10. These fees can impact overall returns. |
Estate Planning Tool: DSTs can be used as an estate planning tool, simplifying the transfer of assets to beneficiaries and potentially reducing estate taxes6. Many DST beneficiaries get a step-up in cost basis6. | Real Estate Risk: This is the same risk as owning any real estate, including your own home. The local market can drop, the economy can decline, or a natural disaster can damage the property. All of these events will affect the condition, income and expense, and eventual sales price of the property9. |
Tax Benefits of DSTs
One of the primary attractions of DSTs is their tax efficiency. The most significant tax benefit is the ability to defer capital gains taxes through a 1031 exchange2. A 1031 exchange allows investors to sell a relinquished property and reinvest the proceeds into a "like-kind" property, deferring the recognition of capital gains. DSTs qualify as "like-kind" property, making them a suitable replacement property in a 1031 exchange5. This deferral can be substantial, potentially saving investors tens of thousands of dollars in taxes. DSTs can help investors avoid missing exchange time windows, which is a significant advantage over traditional 1031 exchanges2.
In addition to capital gains deferral, DST investors can also benefit from depreciation deductions, which can further reduce their tax liability5. Depreciation allows investors to deduct a portion of the property's value each year to account for wear and tear, even if the property is appreciating in value.
There is no Franchise Tax and no Delaware income tax on statutory trusts formed in Delaware12.
DSTs vs. 1031 Exchanges
While DSTs are often used in conjunction with 1031 exchanges, it's important to understand the distinction between the two. A 1031 exchange is a tax strategy, while a DST is an investment vehicle13. A 1031 exchange allows for the tax-deferred exchange of one investment property for another. A DST, on the other hand, is a specific type of trust that holds title to real estate assets.
Investors can use a 1031 exchange to invest in a DST, thereby deferring capital gains taxes while gaining the benefits of passive ownership in institutional-quality assets13. However, it's also possible to invest in a DST without utilizing a 1031 exchange.
DSTs offer greater diversification opportunities compared to traditional 1031 exchanges where investors are limited to one property at a time14. Investors in DSTs don't have to worry about capital gains taxes when they inherit the property15.
Who Should Consider Using DSTs?
DSTs are not suitable for all investors. They are generally best suited for:
Accredited Investors: Due to the illiquidity and complexity of DSTs, they are typically only available to accredited investors who meet certain income and net worth requirements16.
Passive Investors: DSTs are ideal for investors seeking passive income without the burdens of active property management2. This can be particularly appealing for those approaching retirement or those who prefer a hands-off investment approach, especially those with major life changes ahead2.
Investors Seeking Tax Deferral: DSTs offer significant tax advantages, making them attractive to investors looking to defer capital gains taxes on the sale of investment property2.
Investors Seeking Diversification: DSTs allow investors to diversify their real estate holdings across different property types and geographic locations17.
Investors Comfortable with Illiquidity: DST interests are highly illiquid and can't be converted into cash easily18.
Role of Financial Planners and CPAs in DST Investments
Financial planners and CPAs play a crucial role in guiding investors through the complexities of DST investments. They can:
Assess Suitability: Financial planners can help investors determine if DSTs align with their investment goals, risk tolerance, and overall financial plan20.
Tax Planning: CPAs can provide guidance on the tax implications of DST investments, including 1031 exchange rules and depreciation deductions21.
Due Diligence: Financial planners and CPAs can assist investors in conducting due diligence on DST offerings, evaluating the sponsor's track record, the property's financials, and the investment's overall risk profile21.
Coordination: Financial planners can coordinate with other professionals, such as attorneys and qualified intermediaries, to ensure a smooth and compliant DST investment process20.
Risks of DST Investments
While DSTs offer numerous potential benefits, it's crucial for investors to be aware of the associated risks:
No Guarantees: There are no guarantees for monthly distribution amounts or projected appreciation7.
Real Estate Risk: As with any real estate investment, DSTs are subject to market fluctuations, property damage, and other factors that can affect the value and income potential of the property9.
Operator Risk: The performance of a DST is dependent on the expertise and management of the DST sponsor. Poor management decisions can negatively impact the investment9.
Interest Rate Risk: Changes in interest rates can affect the financing costs of the property, potentially reducing cash flow to investors9.
Liquidity Risk: DSTs are illiquid investments, and it may be difficult to sell your interest in the trust if you need to access your money quickly9.
Legal Issues: The structure and management of DSTs can sometimes expose investors to legal issues11.
Dynamic Tax Environment: Tax laws are subject to change, and these changes could affect the tax benefits of DST investments11.
Conclusion
Delaware Statutory Trusts offer a unique investment opportunity, combining the tax advantages of 1031 exchanges with the operational efficiency of passive ownership. DSTs can be an attractive option for those seeking tax deferral, passive income, and diversification in their real estate portfolio, particularly for accredited investors with long-term investment horizons. However, it is essential for investors to carefully consider the pros and cons, conduct thorough due diligence, and seek professional guidance from financial planners and CPAs to make informed decisions about DST investments. To explore DSTs as a potential investment option, consult with your financial advisor and CPA to determine if this investment vehicle aligns with your financial goals and risk tolerance.
Works cited
1. Navigating Delaware Statutory Trusts in Real Estate Investments - Cherry Bekaert, accessed January 9, 2025, https://www.cbh.com/insights/articles/navigating-delaware-statutory-trusts-in-real-estate-investments/
2. How a Delaware Statutory Trust Works | DST Investment - Real Estate Transition Solutions, accessed January 9, 2025, https://www.re-transition.com/investing-delaware-statutory-trust/
3. Why Consider a Delaware Statutory Trust (DST) Investment, Pros and Cons, accessed January 9, 2025, https://www.peachtreegroup.com/delaware-statutory-trust-dst-insights/why-consider-a-delaware-statutory-trust-dst-investment-pros-and-cons
4. The Delaware Statutory Trust (DST) Guide - 1031Gateway, accessed January 9, 2025, https://www.1031gateway.com/delaware-statutory-trust/
5. Delaware Statutory Trust | Baker Tilly, accessed January 9, 2025, https://www.bakertilly.com/specialties/delaware-statutory-trust
6. Delaware Statutory Trust Pros And Cons | Learn The 1031 Benefits, accessed January 9, 2025, https://www.winthcowealthmanagement.com/delaware-statutory-trust-pros-and-cons
7. www.winthcowealthmanagement.com, accessed January 9, 2025, https://www.winthcowealthmanagement.com/risks-1031-exchange-dst#:~:text=Some%20of%20the%20risks%20of%201031%20exchange%20DST%20properties%20may,of%20entire%20principal%20amount%20invested.
8. Delaware Statutory Trust (DST): Advantages & Disadvantages To Consider - Realized 1031, accessed January 9, 2025, https://www.realized1031.com/blog/delaware-statutory-trust-dst-advantages-disadvantages-to-consider
9. DST Benefits and Risks, accessed January 9, 2025, https://www.mymoneymall.com/benefits-and-risks
10. Risks 1031 Exchange DST - What Are The Limitations That May Cost You, accessed January 9, 2025, https://www.winthcowealthmanagement.com/risks-1031-exchange-dst
11. What Risks Are Associated With Investing in a DST? - Sera Capital, accessed January 9, 2025, https://seracapital.com/deferred-sales-trust/what-risks-are-associated-with-investing-in-a-dst/
12. What is a Delaware Statutory Trust? | Harvard Business Services, Inc., accessed January 9, 2025, https://www.delawareinc.com/blog/what-is-a-delaware-statutory-trust/
13. DST and 1031 Exchanges - Bridgeview Real Estate, accessed January 9, 2025, https://bridgeviewre.com/dst-and-1031-exchanges/
14. Delaware Statutory Trust (DST) vs 1031 Exchange - Arizona Commercial Real Estate | ICRE, accessed January 9, 2025, https://investingincre.com/2023/05/25/delaware-statutory-trust-dst-vs-1031-exchange/
15. Understanding DSTs and 1031 Exchanges - National Land Realty, accessed January 9, 2025, https://nationalland.com/what-are-dsts-and-1031s
16. What Are Delaware Statutory Trusts And Why Should Investors Use Them?, accessed January 9, 2025, https://www.matthews.com/thought-leadership-delaware-statutory-trusts-and-why-investors-use-them/
17. Delaware Statutory Trust Pros and Cons - Kay Properties, accessed January 9, 2025, https://www.kpi1031.com/delaware-statutory-trust-advantages/
18. What is a DST? The Benefits of Delaware Statutory Trusts - Origin Investments, accessed January 9, 2025, https://origininvestments.com/what-is-a-dst-the-benefits-of-delaware-statutory-trusts/
19. DST Systems Case Study | TinyMCE, accessed January 9, 2025, https://www.tiny.cloud/customer-stories/dst-systems-case-study/
20. How Financial and Investment Advisors Can Use and Benefit From the DST Process, accessed January 9, 2025, https://reefpointusa.com/how-financial-and-investment-advisors-can-use-and-benefit-from-the-dst-process/
21. What Wealth Managers Should Know About DSTs - Realized 1031, accessed January 9, 2025, https://www.realized1031.com/blog/what-wealth-managers-should-know-about-dsts
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