A Delaware Statutory Trust (DST) owns income-producing real estate and sells percentage shares of ownership to investors who expect to receive income and appreciation. DSTs can offer significant tax benefits through 1031 exchanges that let investors defer or avoid capital gains taxes on profits when selling appreciated real estate properties. DST investors also can avoid day-to-management and purchase higher-end properties than they might otherwise be able to afford. DSTs are illiquid, however, and can only be purchased by accredited investors. Here’s what you need to know.
A financial advisor can help you create a financial plan for real estate investment opportunities like DSTs.
DSTs were created under the laws of Delaware and became popular following a 2004 IRS ruling clarifying their tax treatment. The new real estate investment vehicle grew quickly before suffering, along with the rest of the real estate market, serious reversals during the housing bust and recession that started in 2008.
DSTs are put together by sponsors, generally large commercial real estate firms. These firms identify and research potential properties, then arrange financing to buy them. Next, they set up the DST, transfer the asset to the trust and sell shares to individual investors, who are also known as beneficiaries of the trust. The sponsors continue to manage the properties, receiving fees while distributing income and, ultimately, profits if any from appreciation to beneficiaries.
DSTs may hold one or more properties, which can be of any type of commercial real estate. These include multifamily, retail, office and industrial.
If you are interested in DSTs, here are four advantages for real estate investors:
- The primary benefit of DSTs is that they can be used as replacement properties in 1031 exchanges. A 1031 exchange allows real estate investors to defer paying capital gains when selling property for more than the price paid as long as the proceeds are used to buy a similar property.
- DST investors are entitled to a share of rental income the property generates. Their share is portioned out in accordance with the percentage ownership they have in the trust. When the property is eventually sold, investors can also get a share of any profit. As another tax benefit, they can take advantage of depreciation on the real estate to help shield DST income from taxation.
- Because sponsors manage trust properties, the investors don’t have to concern themselves with collecting rent, paying bills, conducting maintenance or doing repairs. In addition to the hands-off convenience of this passive approach to real estate investing, investors in DSTs don’t have to make personal guarantees to lenders when the property is purchased.
- DSTs give investors the opportunity to own larger, higher quality and more costly properties than they could likely purchase on their own. They can also more easily diversify their holdings, because a single DST can own multiple properties. Purchasing shares in multiple DSTs also provides a way to further diversify by property type, geography and otherwise. And because the sponsor identifies and purchases the property before selling shares in the DST, shareholders may not have to do as much research and due diligence, although they do have to rely on the sponsor doing an adequate job of these important tasks.
7 DST Disadvantages
Before you invest in DSTs, here are seven disadvantages to consider:
- The Securities and Exchange Commission restricts DST investments to accredited investors. This term describes individual investors who have a minimum of $1 million in net investable assets, excluding a primary residence, or have earned $200,000 in each of the previous two years.
- DSTs have relatively high minimum investment requirements compared with other investments. While minimums may be as low as $25,000 per investor, $100,000 is typical.
- DSTs are also illiquid. DSTs cannot be bought or sold on the stock market. Investors have to buy them directly from sponsors or from broker-dealers who have purchased shares from sponsors.
- It’s difficult to exit a DST before the holding period, which usually ranges from five to seven years. After that time, the property in the DST will ordinarily be sold and any gains distributed to investors, who will often use them in another 1031 exchange to avoid capital gains taxes.
- Investors who want to unload their interest before the holding period can’t just place a sell order with a broker. They have to sell their interest directly and only to accredited investors. Plus, the sponsor may have to approve the sale.
- While DST diversification and professional management can mitigate the risk of owning commercial real estate, risks still exist. Cyclical downturns in the real estate market and upturns in interest rates as well as one-time events like the difficulty investors had collecting rent during the COVID pandemic all mean DSTs could fail to provide the expected income and price appreciation.
- If the sponsor’s due diligence fails to reveal structural or other defects in the improvements, the asset may ultimately be worth less than the purchase price. This could place up to the investors’ entire original investment at risk.
DSTs can give real estate investors valuable tax benefits and provide diversification and passive income along with the potential for price appreciation. Investors are shielded from day-to-day management of properties, and can participate in ownership of high-quality properties. However, DSTs are also illiquid, suitable only for affluent investors and subject to market fluctuations or other real estate risks.
Tips for Investing Your Money
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