August 12, 2021
Peter Marzo

Purchasing real estate in today’s market has never been more challenging. Economic uncertainty, competitive markets, local laws and a variety of other factors have added layers of complexity to the purchasing process. 

A few of these complexities today involve:
·         Ability to source, identify, analyze, inspect and value replacement properties
·         Ability to secure financing
·         Ability to secure an appraisal at a sufficient value
·         Ability to successfully 1031 exchange within the 45-day identification & 180-day closing timelines
·         Overpaying in a competitive market
·         Stressful Landlord Responsibility

Fortunately, there is a more simplistic and pragmatic approach to owning real estate, the
Delaware Statutory Trust (DST). In this article we dig into DSTs by answering some of the most common questions, including:
  • What is a Delaware Statutory Trust (DST)?
  • Why invest in a Delaware Statutory Trust?
  • Is a Delaware Statutory Trust eligible for a 1031 exchange?

What is a Delaware Statutory Trust?
A DST is a legal entity created under Delaware statutory law to acquire and maintain assets, such as securities and real estate. Investors then have an opportunity to purchase units of beneficial interests in the trust, thereby becoming limited partners of the trust. The trust is not considered a taxable entity, so all profits, losses, etc. are passed through directly to the beneficiaries.

In other words, think of a DST like owning the shares of a company. You might not own the entire company, but you are entitled to a portion of the gains or losses that the company generates.

Ownership interest in a DST is made available through a sponsor, typically a professional management company, private equity firm or developer. The sponsor will form a DST to purchase a property, then make available a portion of the overall investment to outside investors. As an investor (or limited partner), you can then purchase beneficial shares of interest within the DST.

For example, say a sponsor is purchasing a $50 million office building using a DST and decides to offer $10 million of equity in the deal to outside investors. In this case, if you invested $1 million in equity and $2 million in debt, you would be 6% owner of the DST. Your 6% ownership would then give you access to that portion of the profits or losses of the office building.

Why Invest in a Delaware Statutory Trust?
There are many benefits to investing in a DST that we couldn’t include all of them in this article, so read our article on 10 Advantages of Owning a Delaware Statutory Trust (DST) for the full list.

However, the main benefits that you’ll want to know are that DSTs offer investors potentially higher risk-adjusted returns, better diversification and lower market volatility while eliminating management responsibilities that are affiliated with other forms of real estate ownership. You might not be able to purchase a $100 million office building on your own, but by investing in a DST you can be a part of the action.

Is a Delaware Statutory Trust Eligible for a 1031 Exchange?

In one word, yes.

For the purpose of completing a 1031 exchange, IRS Revenue Ruling 2004-86 opened the way for eligible DST investments to qualify as the replacement property under the “like-kind” requirement in a 1031 exchange. This revenue ruling states that a beneficial interest in a DST that owns real estate can be considered a "direct interest in real estate." As a result, owning interest in a DST that owns real estate equates to holding title on real estate in the eyes of the IRS.

However, to use a DST in a 1031 Exchange, it must comply with the requirements of IRS Revenue Ruling 2004-36 so that a beneficial interest in the trust is treated as an undivided fractional interest in real estate for federal income tax purposes (as opposed to a security or other prohibited interest that would not be treated as real property under Section 1031).

DSTs are commonly used as an identification backup under the “three property rule” of a 1031 exchange, giving investors a way to close on a like-kind property quickly and efficiently if the other identified properties fall through. DSTs are also a flexible way to invest any capital left over from the purchase of other properties during the 1031, known as “boot”, that would otherwise be subject to capital gains tax. 

By utilizing a DST as a part of your investment approach, you are able to defer capital gains taxes via the 1031 exchange and spread your equity by investing into multiple properties, geographic locations, asset classes and tenants.

Investing in a Delaware Statutory Trust is a great way to diversify your portfolio into higher-value properties, while at the same time giving you the ability to defer capital gains taxes through a 1031 exchange.  DST investors can close quickly and own smaller minimum investments making a DST a great option for exchange and boot backup.  Professional asset management also makes owning a DST a passive investment which can serves as a great estate planning tool.  

Our team at Marzo Capital Group has years of experience with DSTs and would be happy to help you navigate the process. If you have any questions about DSTs or are interested in investing in one yourself, get in touch with our experts today.

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