Delaware Statutory Trusts (DSTs)

Delaware Statutory Trusts (DSTs) are widely used to structure 1031-compatible commercial real estate offerings. These DST-structured offerings can be highly valuable to 1031 investors.

Delaware was the first state to enact code governing statutory trusts, which is one reason why DSTs have become popular for real estate investing. DSTs are the only statutory trusts explicitly recognized by the IRS as legal entities that can facilitate a 1031 exchange. This recognition makes DST-structured real estate investments an attractive option for reinvesting capital from a current investment property.

The IRS’s explicit recognition of DSTs as vehicles for 1031 exchanges is accompanied by specific federal instructions on how the trust must be organized and managed. These IRS-imposed regulations create a positive environment for investors in at least two ways:

1.

For a beneficial interest in a DST to qualify as a replacement property in a 1031 exchange, the DST’s governing instrument must ensure that beneficial owners benefit from the DST’s profits. One requirement is that the DST must distribute its profits to investors on a quarterly basis, although sponsors often make these distributions monthly.

2.

Many DST-structured real estate investments are designed to provide investors with passive cash flow from the DST’s profits, appealing to those completing 1031 exchanges. Additionally, if a DST meets the IRS’s conditions for 1031 exchanges, the individual properties held by the trust have the potential to be comparatively reliable assets. The IRS requires that a DST used in a 1031 exchange cannot renegotiate any leases unless a tenant defaults, making such DSTs ideal for holding large industrial or commercial single-tenant properties.

Practical Use of DSTs A DST can take ownership of a large multi-tenant property, such as an apartment complex, using a master lease structure. In this arrangement, the DST leases the property to a single party, who is responsible for providing regular cash flow, and this party then subleases the property to individual tenants. This structure can offer more stability compared to traditional real estate investments, particularly when dealing with tenants suited for non-renegotiable leases.

Suppose you own an investment property that has appreciated in value, and you wish to reinvest your capital into new opportunities. You may face a dilemma:

Deferring Capital Gains Taxes

You want your investment capital to grow without being hindered by capital gains taxes. You might also appreciate the cash flow that real estate investments provide. This scenario favors deferring capital gains taxes by reinvesting your capital into like-kind real estate through a 1031 exchange, as outlined in IRC §1031.

Avoiding Landlord Hassles and Diversification

You may be reluctant to reinvest in real estate due to the challenges of being a landlord. Additionally, you might prefer to diversify your investments rather than concentrating your capital in a few properties. This could lead you to consider realizing your capital gain and paying the associated taxes.

The basic investment strategy using a DST is as follows:

Utilize IRC Section 1031

Exchange the proceeds from the sale of your original property for an interest in a DST, which owns multiple high-quality commercial properties. By doing so, you acquire a fractional interest in these properties alongside other investors.

Passive Management

Unlike direct real estate ownership, a DST-structured investment transfers management responsibilities to the sponsor, who acts as a trustee. The IRS treats DSTs in a manner that satisfies 1031 exchange requirements, allowing you to defer capital gains taxes.

Diversification and Passive Income

Reinvesting your capital in a DST provides a diversified, passive income-producing investment while deferring capital gains taxes on the sale of your original property.