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  • Writer's pictureE.R.Cornwell

DST: What are they and how are they used in 1031 exchanges?

A Delaware Statutory Trust or DST is a legal entity constructed under Delaware law. In a DST, each investor has an ownership interest in the Trust, which in turn owns the property. Investors are known as “beneficiaries” of the Trust similar to any other Trust scenario. For these reasons, the security that an investor in a DST owns are called “beneficiary interests” and not "shares" or "member interest". The IRS treats DST beneficiary interests as direct property ownership, thus qualifying for a 1031 exchange (for more information in 1031 exchanges, please reach out to us directly).

DSTs give investors with limited funds the ability to obtain commercial properties such as retail spaces, apartment complexes, or industrial assets. Once you have passive ownership in one of these properties, you can continue using 1031 exchanges to defer tax liability and grow your wealth by investing in additional high-end assets.

Some advantages of DSTs include the following:

  • Limited Liability similar to and LLC or corporation.. The DST structure shields investors from personal liabilities beyond the amount of their investment, similar to an LLC or corporation.

  • Bankruptcy protection against creditors pursuing individual investors.

  • Control is centralized to one Trustee.

  • Single borrower makes borrowing easier.

  • High limits to number of investors give access to almost unlimited capital.

  • Relatively simple for investors to use the 1031 exchange funds to purchase one or more fractional, DST investments.

That stated, DSTs do have their limitations. In order to qualify for 1031 exchange purposes, DSTs are subject to certain collars. They are:

  • Once the DST is closed, investors are not allowed to make additional capital contributions;

  • The Trustee cannot renegotiate terms of existing loans nor borrow any new funds;

  • When a property that is owned by a DST is sold, the Trustee must return these proceed to the investors and cannot invest them in another property;

  • Capital expenditures the DST can make on the properties it owns are limited to (a) normal repair and maintenance, (b) non-structural improvements and (c) those required by law;

  • Cash held by the DST between distributions to the investors may only be invested in short-term debt securities, like US Treasury bills;

  • All cash, other than reserves, must be regularly distributed to the Beneficiaries; and

  • The Trustee cannot enter into new leases or renegotiate current leases.

Investments through DSTs are an attractive option for many 1031 exchange investors. The structure allows investors to participate in larger, higher-quality assets than they may otherwise be able to invest in. Because they are pre-packaged, it makes the process of investing and meeting exchange requirement timelines relatively simple for investors. DSTs do have their limitations and are generally best suited for investors seeking a longer-term, passive investment.

This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. We are not legal or tax advisors, and we recommend consulting your own professionals.

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