The Benefits of DSTs for Real Estate Investors

What exactly is a DST (Delaware Statutory Trust)?

For authorized investors who want to make fractional real estate investments, a Delaware Statutory Trust, or DST, is a frequently used structure.

The main benefit of investing in a DST is that it qualifies for a 1031 Exchange, which enables investors who are selling a property to postpone paying capital gains tax by putting the profits into a DST, which the IRS has determined is an investment of "like kind."

National real estate corporations typically "sponsor," or bring to market and make available to accredited investors, DST offers. These offerings can be made available through third-party securities broker-dealers. The property(ies) to be offered under the trust are purchased by DST sponsors. In order to make sure the trust is eligible for 1031 exchange purposes, the DST sponsor will perform due diligence on the property, occasionally acquire long-term debt that is non-recourse to investors, and organize the necessary paperwork. The DST sponsor will then offer the asset(s) to accredited investors on a fractional ownership basis, and in exchange will get payment for organizing, supervising, and managing the investment on their behalf.

The Evolution of DSTs

Tenant-in-common real estate, or "TICs," is a type of co-ownership that is discussed in more detail below. In the early 2000s, some of the biggest real estate sponsors in the country and their attorneys urged the IRS to create regulations that would allow TICs to qualify for 1031 exchanges. Investment in TICs soared as a result. Investors soon encountered some of the difficulties brought on by TICs, such as the requirement for investor unanimity in order to make certain sorts of property-related decisions.

The idea of investing through a DST started to catch hold at about this time. DSTs offered more flexibility than TICs and addressed some of the concerns of investors, notably with regard to the clauses requiring unanimous consent.

It was no surprise, then, that investors and sponsors asked the IRS to adopt identical 1031 exchange standards for DSTs. As a result, the IRS released Revenue Ruling 2004-86 in 2004 that permitted the use of the DST structure to buy real estate where the trust's beneficial interests would be recognized as direct interests in replacement property for the purposes of a 1031 exchange. The syndicated real estate sector hailed this as a significant triumph.

Prior to the start of the Great Recession in 2008, both TICs and DSTs were commonly utilized. Their appeal declined along with real estate values. TICs were impacted more than DSTs. Few individual investors were willing to assume the risk of jointly owning so much underwater real estate. At least with DSTs, the DST sponsor was responsible for loan repayment, not individual investors. Investment in real estate syndication increased as the economy strengthened. Given the difficulties involved with TICs, DSTs are now frequently regarded as the preferred way of fractional real estate ownership.

The Distinction Between DSTs and TICs

For long-time real estate investors, DSTs are a relatively new notion. Instead, tenant-in-common real estate investments, or TICs, are more commonly known to long-term investors. Both TICs and DSTs allow people to invest fractionally in real estate. They can both be combined with 1031 exchanges. As a result, it is understandable why some individuals mistake TICs for DSTs. There are, however, some significant differences between the two.

The degree of investor involvement is a key area of distinction. The co-owners of a TIC are typically more actively involved in managing the property on a day-to-day basis, including property management. DSTs are really passive investments in which the sponsor manages the transaction on the part of the investors.

The need for unanimous co-owner approval for all significant actions is one of the reasons management of TICs may be so difficult. In actuality, this is one of the difficulties that prompted the development of DSTs. Many investors were put off by the unanimous approval needed for TICs, and those who had previously invested in TICs encountered difficulties.

Another difference between TICs and DSTs is how they hold title to the property. Each TIC co-owner has a little portion of the property's title. Individual investors do not actually own the real estate asset; instead, the DST does. In terms of financing, this has consequences. The individual co-owners of a TIC are liable for any debt used to fund the property, whether for acquisition or upgrades. This makes it necessary for lenders to individually vet each borrower, which can be time-consuming for most of them and make it challenging to finance real estate held in TICs. Since the asset is solely held by the DST on behalf of the investors in a trust arrangement, DST investors do not directly incur debt.

TICs and DSTs also differ in terms of the number of investors authorized to participate. In contrast to DSTs, which are limited to 499 individual investors, TICs are only permitted to have 35 investors (or "co-owners").

Finally, the minimum investment for DSTs is typically lower than that of TICs because more investors can engage in them. Compared to DSTs, which typically permit contributions as little as $100,000, many TICs need at least a $500,000 commitment (or sometimes less).

How are DSTs Used by Investors?

An investor can benefit from the advantages DSTs provide in one of two ways. Investing with funds from a 1031 exchange is the first and most common method. Direct cash investment into a DST is the alternative.

1031 Exchanges
Traditionally, an investor wanting to avoid paying capital gains tax on the sale of a real estate asset will perform a 1031 exchange and utilize the profits from the sale to invest in another "like kind" asset. However, there are stringent rules for 1031 exchanges. In accordance with current regulations, for instance, investors must:

Find a potential replacement property within 45 days of the sale. Close on the replacement property(s) within 180 days of the sale. Reinvest 100% of net sales proceeds, also known as equity, into the replacement property. Acquire an equal or greater amount of debt on the replacement property.
It can be challenging to meet these requirements, especially in the competitive real estate market of today.

DSTs are a 1031 exchange alternative for "whole property."

Investors can instead transfer the money received from the sale of their property into a DST. The investor will thereafter possess proportionally fractional ownership in the property (or properties) owned by the DST. DSTs are already in place (or "pre-packaged," if you prefer) and prepared to receive investors, enabling someone selling their property to typically move fast in conformity with the IRS's 1031 exchange standards. All due diligence on the actual estate is already complete. Additionally, under present law, the profits from the sale of the investors' property will be eligible for the same capital gains tax deferral as if the investors had invested via a whole property 1031 exchange.

Investors occasionally combine methods by purchasing both a DST and a full property. When an investor discovers a suitable replacement property (or properties), it frequently happens that they still have extra money from the sale of their former asset. To fully benefit from the present law's 1031 exchange benefits, the investor may use the remaining sales proceeds and invest that money in a DST.

• Investments in Direct Cash
  Accredited investors can purchase DSTs without selling any of their own properties. This is a fantastic option for individuals who want to start investing in diversified passive real estate. There is often a $25,000 minimum investment requirement for direct cash investments in most DSTs. Accredited investors seeking access to institutional-quality and other high-value real estate that they would not be able to afford on their own would find this to be a particularly appealing alternative.

Potential Rewards of DST Investment

There are several potential benefits of investing in a DST, several of which are described below:

• Capital preservation tool: As previously mentioned, DSTs offer investors an excellent option to postpone paying capital gains tax on the revenues from the sale of their other real estate. They can get the same advantages by investing in a DST as opposed to performing a "whole property" 1031 exchange. According to existing law, investors can reinvest in another DST or sole-ownership property to continue postponing paying capital gains taxes indefinitely after the DST program expires or the asset is sold.
• Quickness: Finding a suitable like-kind property to buy within constrained IRS timeframes is typically the main obstacle for people attempting to complete a standard 1031 exchange. This is especially true in the competitive real estate market of today, where there aren't as many "bargains" to be found. Investors still need to perform extensive due research on every potential opportunity, and it can frequently be difficult to discover a property that satisfies their investment criteria within the allotted time. DSTs provide pre-investment-ready real estate that has previously undergone a rigorous review. This enables sellers to move fast while continuing to benefit from the tax advantages of a 1031 exchange.
• Additional inventory to take into account: Many investors who are looking to complete a 1031 exchange find themselves under pressure to trade up into a property that they otherwise might not buy because of the 1031-time restrictions. When you invest in a DST, you have access to a larger selection of properties, including those that have undergone comprehensive inspection by some of the top players in the market. This can assist lower the likelihood of making a "poor" investment for folks who might otherwise make a quick decision given timeline pressures.
• No need for active management: Those who use a standard 1031 exchange to trade-up into a better value asset are still responsible for managing the real estate. Instead, customers who invest their sale proceeds into a DST transfer management duties to the DST's sponsor, who manages the real estate holdings on their behalf. As a result, an investor can convert real estate that they actively own and control into 100% passive real estate.
• Less expensive to finance and no personal liability for DST debt: Unlike TICs, investors in DSTs are not held personally responsible for any debt incurred in connection with the asset. The sponsor is the only party accountable to the lenders. Real estate held in DSTs is also simpler to finance since, unlike with TICs, the lender simply underwrites the sponsor, which is often a sizable, renowned institutional real estate corporation with a proven track record.
• Access to institutional-quality assets: Due to the price and funding required to invest in higher-quality real estate, those who directly purchase property are frequently restricted to assets of a specific caliber. Given its fractional ownership format, a DST enables those wishing to invest in assets of institutional quality. An ordinary investor can acquire a tiny stake in a high-quality asset through a DST, which lowers entry barriers.
• Diversification: A variety of DST real estate investments, including multifamily, storage space, office, and NNN leases, are available to investors from different DST sponsors. Additionally, you can invest in a specific type of DST, like multifamily, across a number of different geographic areas of the nation, increasing the likelihood that other locations won't experience a downturn in their local economies or, at the very least, lowering the likelihood that they will due to diversification.

Conclusion

As you can see, there are a lot of reasons why an investor should think about making a DST-based real estate investment. For investors seeking to fully benefit from advantages normally associated with conventional 1031 exchanges, the DST model offers exceptional flexibility, opportunity, and investment variety.

Additionally, investors can close on DST investments rapidly — frequently in a matter of days. Therefore, investing in a DST can be a terrific alternative whether you're an accredited investor looking to deploy your funds for the first time or someone who has a strict deadline to do so after a 1031 sale.

Are you eager to discover more about DSTs? Contact us today at Perch Wealth to discover more about our current DST real estate offers and how we might possibly help you.

General Information
neither a buy-side nor a sell-side solicitation of securities. The material presented here is purely for informational purposes and shouldn't be used to guide financial decisions. Every investment has the chance of losing some or all of the money. Future outcomes cannot be predicted based on past performance. Prior to investing, consult a financial or tax expert.

Financial products made available by Emerson Equity LLC Member: SIPC/FINRA. Only accessible in states where Emerson Equity LLC has a recognized business presence. There are no other organizations mentioned in this correspondence with whom Emerson Equity LLC is associated.

1031 Risk Disclosure: * There is no assurance that any strategy will be effective or achieve investment goals; * Property value loss is a possibility for all real estate investments over the course of ownership; * Tax status may change depending on the income stream and depreciation schedule for any investment property. All funded real estate investments have the risk of going into foreclosure; adverse tax rulings may prevent capital gains from being deferred and result in immediate tax liability;
1031 exchanges are illiquid assets since they are frequently issued through private placement offerings. There is no secondary market for these investments. * Reduction or Elimination of Monthly Cash Flow Distributions - Similar to any real estate investment, the possibility of suspension of cash flow distributions exists in the event that a property unexpectedly loses tenants or suffers significant damage;

• The impact of fees and expenses - The costs of the transaction could have an influence on investors' returns and even surpass the tax advantages.