Most real estate investors know that they have several options when choosing how to invest in real property. However, one investment vehicle is often unknown to investors. This vehicle is called a Delaware Statutory Trust (DST). A DST often has advantages over other forms of real property ownership. It can be an initial investment or can be replacement property in a §1031 exchange. DSTs are highly regulated, must comply with IRS Rev. Rul. 2004-86 and must meet lender requirements. Although DST ownership, as with any investment, is not without risk, its structure can benefit the specific needs of the right investors. DST offerings give investors the opportunity to own a different class of property than they otherwise might be able to afford if they were trying to acquire it themselves. Often DST deals are large multi-family properties, class A office buildings, and triple net leases with large national retail corporations.
When using a DST investment as replacement property for a §1031 exchange, it offers some advantages over directly ownership of the replacement property. Often investors are looking to replace a sold property but do not want to commit additional investment funds to the new replacement purchase. A DST investment is the perfect option for such a scenario. Prior to or at the time of sale of the relinquished property the clock begins ticking on the deadline to both identify (45 days from sale) and close on the acquisition of replacement property (180 days from sale). Investors are not only tasked with choosing the right property to acquire but ultimately must close within the 180 days. DST offerings are generally on a specified timeline for settlement and investors can typically close within a matter of days once they commit to the investment. Not only that, but whatever funds are available for reinvestment from the first sale can generally be invested directly in the DST with no overpayment or shortfall. You simply receive a fractional ownership percent in the DST that corresponds to the exact amount of capital invested in the deal. Under this scenario an investor can confidently sell a property and quickly close on the required replacement property without the stress and worry that their exchange will fail, potentially resulting in thousands of dollars of tax.
Most often, DST offerings are large acquisitions with up to 499 owners. This limit is typically set by the DST sponsor. They can also be tailored to a particular investor depending on the investment size.
One pitfall to watch out for is selecting the right DST investment. When selecting a property, one must consider the location of the rental property. For example, if a California resident sells CA real property in an exchange, then acquires a fractional interest in a DST offering that owns multiple retail store locations in numerous states may not be the best option. This can unexpectedly and in some cases, needlessly increase the complexity of the investor’s personal tax returns. A smaller investor might go from filing in their resident state to filing in 8 or more states depending upon the DST’s property locations. Filing in these additional states can add significant time and additional costs to tax preparation fees. If the size of the investment is small, one must justify the cash flow resulting from the new investment against the increased professional fees for tax compliance.
If you are considering a §1031 exchange of real property, a DST investment may meet your needs and solve the timing and funding dilemma.
For more information about Delaware Statutory Trusts and other tax planning considerations, call LSL CPAs at 714.672.0022.
Written by: Pamela A. Bustos, MST, CPA
