A large part of the American Dream has always been to own real estate, whether it be your principal residence or a direct investment in owning land or other rental real estate. Often investors enter into the ownership of rental real estate with the best of intentions and goals; appreciation of the real estate value, increased cash flow and tax benefits due to depreciation. However, they often overlook the time constraints involved with the other aspects of rental real estate, such as dealing with tenants and their lease agreements, property maintenance, and the time required to handle such tasks. Even if a management company is hired to manage the property, certain ongoing decisions are required of the owner.
One structure available to owners of rental real estate through a §1031 exchange is that of a Delaware Statutory Trust (DST). The DST must comply with IRS Rev. Rul. 2004-86 and meet lender requirements. Though DST ownership is not without risk, this structure has numerous advantages over direct ownership of real estate or through a tenant-in-common (TIC) arrangement.
DSTs may be owned by an unlimited number of beneficial owners, however most sponsors permit a maximum of 499 owners in a particular deal. Depending upon the size of the investment, a sponsor may structure a deal with just the trustee and the one beneficial owner to meet the specific investment profile the investor is looking to own.
Ownership of real estate through a DST can have substantial benefits over other forms of real property ownership. Due to their nature, DSTs are highly regulated and must meet stringent requirements to qualify. Some of the benefits of being a DST investor include not having to make any additional cash investment into the property other than the initial investment. The DST is managed by a minimum of one trustee, therefore in times of crisis, the DST has the advantage over the TIC structure of having centralized decision making, whereas in a TIC all major decisions must be unanimous.
Depending on the size of the real estate being traded into in a typical §1031 exchange, the investor may be limited as to the types of property they may acquire due to price constraints. However, in a DST the DST investor may invest in a much larger property while making an investment that is only a fraction of the entire deal. This may give the investor the opportunity to invest in higher quality real estate, such as anchor buildings in commercial shopping centers or large apartment complexes the investor would otherwise be unable to afford. Regardless of the size of the investment, the reporting from a DST is similar to that of a TIC, though often the reports are much more simplified. They typically show the 100% amounts for both balance sheet and income statement, plus they report the fractional ownership of each investor. Also information is typically given regarding the breakdown of the property held by location both for the real property assets as well as for the income and expenses. The basis of the assets in the hands of the investor are determined by each investor, as their basis will differ depending upon how the DST ownership was acquired, either through a §1031 exchange or through direct purchase.
If you hold real estate and are considering an exchange of your property, ownership in a DST may eliminate the headaches that can be associated with direct ownership and may offer you significant advantages over other forms of ownership.
For more information about Delaware Statutory Trusts and other real estate ownership strategies call LSL CPAs at 714.569.1000
By Pam Bustos, CPA
