What do you do when you finally get the dream offer on an investment property you have owned for 10 plus years and are either tired of the toilets, tenants, and trash of property management or just cannot justify relinquishing your property just to make a lateral move into someone else’s headache?
If this is a dilemma that your facing right now in this very hot market and you are an accredited investor, you should be asking your real estate attorney or CPA about a 1031 Exchange utilizing the Delaware Statutory Trust (DST).
A 1031 DST gives a seller the ability to sell their highly appreciated property and diversify into multiple sectors, such as healthcare, multifamily, big box net retail, student housing, on a percentage ownership basis into each DST. Some of the minimum investments into DST offering are as little as $100,000.00 making it very easy to diversify smaller exchanges.
As long as the purchaser of the DST is 100% ok being a passive investor and handing the reins over to some of the largest real estate firms in the United States, such as Inland Private Capital Corporation, for example, to make the decisions on when to sell the property and give the investor the ability to do another 1031 exchange on their own or continue exchanging into new DST programs offered by many different national sponsors. This could be a great estate planning and wealth building option an accredited investor could potentially utilize.
DST’s come in all shapes and sizes; some being an all cash offering and some having a loan to value as high as 80%. If the client needs to replace debt on their exchange a major benefit of a DST is the debt is already in place at the sponsor level. There is no underwriting of the purchaser and the debt does not even show up on the investors credit. If a client is all cash and depreciated his relinquished property down to zero, he can diversify into multiple DST’s and include some properties with debt or ones with all debt thereby increasing his cost basis and receiving all of the potential benefits of the assumed debt but the debt remains nonrecourse to the investor.
Here are some key points regarding DST’s:
In accordance with the Internal Revenue Service’s Revenue Ruling 2004-86, a beneficial interest in a Delaware statutory trust, or “DST,” that holds a replacement property may be considered “like-kind” replacement property in a Section 1031 exchange. A DST may own one or more properties. The rights and obligations of investors in a DST will be governed by the DST’s trust agreement. Typically, investors have limited voting rights over the operation and ownership of any properties owned by the DST. In addition, the trustees of the DST may be entitled to certain fees and reimbursements, as set forth in the applicable trust agreement.
The Seven Deadly Sins: Internal Revenue Ruling 2004-86, which forms the income tax authority for structuring a Delaware Statutory Trust or DST transaction for use with a 1031 Exchange has prohibitions over the powers of the Trustee of the Delaware Statutory Trust of DST, which are known as the “seven deadly sins,” and include the following:
1. Once the offering is closed, there can be no future equity contribution to the Delaware Statutory Trust or DST by either current or new co-investors or beneficiaries.
2. The Trustee of the Delaware Statutory Trust or DST cannot renegotiate the terms of the existing loans, nor can it borrow any new funds from any other lender or party.
3. The Trustee cannot reinvest the proceeds from the sale of its investment real estate.
4. The Trustee is limited to making capital expenditures with respect to the property to those for a) normal repair and maintenance, (b) minor non-structural capital improvements, and (c) those required by law.
5. Any liquid cash held in the Delaware Statutory Trust or DST between distribution dates can only be invested in short-term debt obligations.
6. All cash, other than necessary reserves, must be distributed to the co-investors or beneficiaries on a current basis, and
7. The Trustee cannot enter into new leases or renegotiate the current leases.
The Springing LLC
The Delaware Statutory Trust of DST agreement may contain a provision that provides that if the Trustee determines that the DST is in danger of losing the property due to its inability to act because of the prohibitions in the trust agreement (the seven deadly sins), it can convert the Delaware Statutory Trust or DST into a limited liability company (hereinafter referred to as the Springing LLC) with pre-existing agreed-upon terms.
The laws of the state of Delaware permit the conversion to a limited liability company through a simple filing with the office of the Secretary of State. The Springing LLC will contain the same bankruptcy remote provisions as the Delaware Statutory Trust of DST for the lender’s benefit, but it will not contain the prohibitions against the raising of additional funds, the raising of new financing or the renegotiation or the terms of the existing debt or entering into new leases. In addition, it will provide that the Trustee will become the manager of the limited liability company.
Investors Seek the Potential Benefits of the Delaware Statutory Trust
Co-investors or beneficiaries looking for the tax benefits of a 1031 Exchange coupled with the advantages of co-ownership or fractional ownership in investment real estate are increasingly seeking the popular alternatives of Delaware Statutory Trusts or DST co-investor. Recently, the Delaware Statutory Trusts or DSTs have been gaining popularity for a number of reasons including the ability to secure financing more easily and attract more co-investors with lower minimum investment requirements. The Internal Revenue Service issued Revenue Ruling 2004-86 that sets out the guidelines for the Delaware Statutory Trust or DST. Delaware Statutory Trusts are trusts that are considered to be separate legal entities pursuant to the trust laws of the state of Delaware.
Each individual that co-invests in or through a Delaware Statutory trust or DST is a beneficiary of the Delaware Statutory Trust and therefore owns a “beneficial interest” in the DST for Federal income tax purposes. The co-investor or beneficiary is treated as owning an undivided fractional interest in the underlying investment real property.
One of the primary potential benefits of the Delaware Statutory Trust or DST Investment Property structure is the ease of obtaining financing compared to the Tenant-In-Common or TIC Investment Property structure. Lenders view the Delaware Statutory Trust as one borrower even though there can be up to 99 individual investors or beneficiaries.
Please feel free to reach out to me for more information regarding 1031 DST Exchanges and how this could help your existing clients complete their 1031 exchange.
DST 1031 properties are only available to accredited investors (generally described as having a net worth of over $1 million dollars exclusive of primary residence) and accredited entities only. If you are unsure if you are an accredited investor and/or an accredited entity please verify with your CPA and Attorney. There are risks associated with investing in real estate and Delaware Statutory Trust (DST) properties including, but not limited to, loss of entire investment principal, declining market values, tenant vacancies and illiquidity. Diversification does not guarantee profits or guarantee protection against losses. Potential cash flows/returns/appreciation are not guaranteed and could be lower than anticipated. The information herein has been prepared for educational purposes only and does not constitute an offer to purchase or sell securitized real estate investments. Because investors situations and objectives vary this information is not intended to indicate suitability for any particular investor. This material is not to be interpreted as tax or legal advice. Please speak with your own tax and legal advisors for advice/guidance regarding your particular situation. Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Advisory services offered through Concorde Asset Management, LLC (CAM), an SEC registered investment adviser. Insurance products offered through Concorde Insurance Agency, Inc. (CIA). Fortitude Investment Group is independent of CIS, CAM and CIA
This article was written by Jeffrey Alan Kiesnoski/Co-Founder & Managing Director of Fortitude Investment Group LLC. Please visit our website at www.1031dst.com for more information.