DST investments are highly illiquid. Due to the strict trust agreement between the trustees and the investors, you cannot access the funds you contribute during the agreed holding period, which can last between 7 and 15 years. Although DSTs make regular cash distributions of profits to their beneficiaries, your principal investment remains inaccessible during this period.
With DST-structured investments, you gain freedom from property management but lose the ability to participate in management decisions. As a beneficiary rather than a trustee, you are not involved in the practical management or eventual sale of the trust’s properties. Therefore, it is crucial to find a trustworthy sponsor with a strong track record in managing similar offerings.
The sponsor’s role is significant. A DST offering is only as good as its underlying properties. If you choose the wrong sponsor, you may invest in properties purchased at prices higher than comparable assets in similar markets. Evaluate the due diligence materials provided by sponsors and review the past performance of their DST offerings. Additionally, the interests of sponsors can diverge from your interests as an investor. Even if a DST-structured investment fails to yield profits, the sponsor can still collect fees. Sponsors might also hold properties longer than optimal for investors due to other fiduciary duties. Hence, a thorough background check of the sponsor’s history is essential.
If you own an investment property outright and want to perform a 1031 exchange, acquiring a beneficial interest in a DST that uses leverage incurs the risk of lender foreclosure. High loan-to-value ratios can diminish investor cash flow due to vacancy or unforeseen costs. Defaulting on such a loan can cause the DST to convert to an LLC, jeopardizing your ability to execute future 1031 exchanges.
DST investments that use leverage vary in the amount of leverage and loan repayment terms. Some loans are interest-only, requiring only interest payments during the holding period, with the principal repaid from the sale proceeds of the DST’s properties. Others are fully amortizing, requiring total loan repayment by the end of the holding period, which can affect cash distributions to investors.
DSTs can facilitate a 1031 exchange, but they must be structured correctly. The DST must be managed to ensure your initial 1031 exchange holds during an audit and to enable future 1031 exchanges. Verify that the DST offering is designed to facilitate your 1031 exchange and has a clear exit strategy.
For your beneficial interest in a DST to qualify for a 1031 exchange, it must be structured to provide you with a beneficial interest in the property owned by the DST. The holdings of the DST must meet the constraints given by Rev. Rul. 2004-86 to be eligible for a 1031 exchange.
Poorly organized DSTs can prevent investors from completing 1031 exchanges. If all goes well with your DST investment, you can perform a 1031 exchange after the DST’s holding period. The proceeds from the DST’s property sales can be held by a Qualified Intermediary and used to acquire replacement properties, including interests in another DST.
However, exiting the DST investment using a 1031 exchange is only possible if you hold equitable title to the properties at the time of disposal. A DST may convert to an LLC for various reasons, such as loan default, failure to sell properties in a reasonable period, or reaching the trust’s expiration date, which can prevent you from executing future 1031 exchanges.