What is a Delaware Statutory Trust and Why So Many Real Estate Investors Are Interested in Them?

Discover the often overlooked benefits of the Delaware Statutory Trust and 1031 Exchange laws, and how you can take advantage of them for your real estate investing strategies.

By Matt McFarland, Vice President, & Thomas Wall, Associate, Kay Properties & Investments

The Kay Properties team recently participated in an investment property industry trade show, and were pleased to see so many people stopping by our booth asking about Delaware Statutory Trust 1031 exchanges. However, because we found ourselves answering the same questions again and again from some very experienced investment property owners, we thought it might be a good idea to write about the three most commonly asked questions we heard that relate to DST 1031 Exchanges, including:

1. What Is A Delaware Statutory Trust And What Are The Associated Risks?

2. What can a Delaware Statutory Trust do for me?

3. Do I have to have a Delaware address to invest in a Delaware Statutory Trust?

First, of course you don’t have to live in Delaware to invest in a “Delaware Statutory Trust.” Delaware was the state where the law defining a DST and its structure was created, and what’s so special about this real estate investment vehicle is that it’s blessed by the IRS to qualify as “like-kind” investment property for the purposes of a 1031 exchange. Internal Revenue Code (IRC) Section 1031 allows investors to postpone paying tax on the gain of a relinquished property by reinvesting the proceeds in similar property as part of a qualifying like-kind exchange.

What is a Delaware Statutory Trust?

A Delaware Statutory Trust is a real estate ownership structure that allows multiple investors to each hold an undivided beneficial interest in the holdings of the trust. The term “beneficial interest” means that investors hold a percentage of the ownership, and no single owner can claim exclusive ownership over any specific aspect of the real estate. The laws of DSTs allow the trust to hold title to one or more investment properties that can include commercial, multifamily, net lease, retail, office, industrial, self-storage, etc.

Potential Benefits of a Delaware Statutory Trust

1. Eliminating the day-today headaches of property management

Many participant investors in DST 1031 properties are at or near retirement and are tired of the hassles that real estate ownership and management often bring. They are tired of the proverbial “3 T’s” of multifamily residential real estate: tenants, toilets, and trash, and just want to move away from actively managing properties.

The DST 1031 property provides a 100 percent passive ownership structure, allowing investors to enjoy retirement, grandkids, travel, and leisure, as well as to focus on other things they are more passionate about instead of property management headaches. Obviously, as with all forms of real estate investments, there is an underlying level of risk that investors should be aware of including things like economic downturns, vacancies, tenant repairs, etc.

2. Tax deferral using the 1031 exchange

Many of our clients have wanted to sell their apartments, rentals, and commercial properties for years but haven’t been able to find a property to exchange into and just can’t stomach the tax bill after adding up federal capital gains tax, state capital gains tax, depreciation recapture tax and the Medicare surtax.

The DST 1031 property solution can potentially provide investors an ability to move from an active to a passive role of real estate ownership on a tax-deferred basis while still potentially receiving passive income. Also, because a 1031 exchange has very tight timelines (45 days to identify exchange property and 180 days to complete the exchange), DST investors can close quickly and complete their exchanges within 3 to five days as opposed to having to wait 30, 60, 90 days to purchase another outside property.

Investors are strongly encouraged to consult their CPA and tax attorney regarding the potential tax advantages as well as risks associated with any DST 1031 Exchange properties. Furthermore, investors are encouraged to read the entire Private Placement Memorandum (PPM) for a full discussion of the risks and business plan of each offering.

3. Increased cash flow potential

Many investors of real estate may be unhappy with the amount of cash flow they are receiving due to recent eviction moratoriums, under-market rent structure, multiple vacancies and/or that the raw or vacant land is sitting idle and unproductive. DST 1031 Exchange properties provide an opportunity for investors to potentially increase their cash flow on their real estate holdings via a tax deferred 1031 exchange. This potential passive cash flow can come about from regular monthly payments from their DST 1031 investments. All real estate investments provide no guarantees for cash flow, distributions or appreciation as well as could result in a full loss of invested principal.

4. Portfolio diversification by geography and property types

Often, 1031 investors are selling a property that comprises a substantial amount of their net worth. They want to reduce their potential risk and instead of buying one property (such as another apartment building) or a singleNNN building (such as a Walgreens or Taco Bell) they decide that investing into a diversified portfolio of DST 1031 properties with multiple locations, asset classes (property types) and tenants is a better fit for their goals and objectives. Still, investors should also understand that diversification does not guarantee profits or protect against losses.

What Properties Can Be Used In a 1031 Exchange?

If you are interested in selling your investment real estate, the phrase “1031 exchange” has certainly come up once or twice in your research, as an outright sale (“cashing out”) can trigger large tax consequences. The capital gains, medicare surcharge, and depreciation recapture taxes can create a serious dent in the return you expected to earn from the sale be part of your real estate.

A 1031 exchange is a process by which an investor can defer the taxes they would pay upon sale of their investment property. It is important to understand how the 1031 exchange can be utilized. A 1031 exchange may be performed if the property sold and the following property or properties purchased are both considered investment property.

Investment properties are those that are used for business or investment purposes. Raw land, land with mineral rights, multifamily, and commercial real estate can all qualify as “like-kind” for the purposes of a 1031 exchange. Any property that falls outside that definition would not qualify. A primary residence or any property in which one stays more than two weeks in a year is NOT considered an investment property.

Again, an investment property must be exchanged for another investment property. Properties can only be exchanged if they are used for investment purposes like residential rentals, multifamily, condominiums for rent, commercial, industrial, retail etc.

Furthermore, there are many 1031 exchange alternatives one may consider. A Delaware Statutory Trust (DST) is a great example. With DST real estate, an investor is able to exchange into properties and own a “beneficial interest” in the real estate.

Instead of investing the entirety of the proceeds into another property, one for one, an individual is able to invest in multiple pieces of property as a fractional and passive owner. Under the DST structure, fractional real estate ownership is still considered eligible for 1031 exchange. This is a helpful way to potentially diversify into a portfolio of properties, thereby buffering the risk of having “all your eggs in one basket” by buying a single property.

Utilizing the DST structure, one can own a beneficial interest of multiple properties with the opportunity for several geographic locations as well as with various asset managers running each real estate investment as part of a diversified 1031 solution into DSTs. These are illustrative examples of 1031 DST offerings. Future available 1031 DST offerings and tenants may be different. Diversification does not guarantee profits or protect against losses.

Finally, the IRS clearly specifies that some real property held primarily for sale does not qualify for tax deferral under section 1031.The following are examples of properties that do not qualify for tax-deferred exchange treatment:

✔ Stock in trade or other property held primarily for sale (i.e. property held by a developer, “flipper” or other dealer)

✔ Securities or other evidences of indebtedness or interest

✔ Stocks, bonds, or notes

✔ Certificates of trust or beneficial interests

✔ Interests in a partnership

✔ Choses in action (rights to receive money or other property by judicial proceeding)

✔ Foreign real property for U.S. real property

✔ Goodwill of one business for goodwill of another business

To learn more about 1031 exchanges and Delaware Statutory Trusts, please visit www.1031dstdigest.com.

This material does not constitute an offer to sell nor a solicitation of an offer to buy any security. Such offers can be made only by the confidential Private Placement Memorandum (the “Memorandum”). Please read the entire Memorandum paying special attention to the risk section prior investing. IRC Section 1031, IRC Section 1033 and IRC Section 721 are complex tax codes therefore you should consult your tax or legal professional for details regarding your situation. This material is not to be construed as tax or legal advice. There are material risks associated with investing in real estate securities including illiquidity, vacancies, general market conditions and competition, lack of operating history, interest rate risks, general risks of owning/operating commercial and multifamily properties, financing risks, potential adverse tax consequences, general economic risks, development risks and long hold periods. There is a risk of loss of the entire investment principal. Past performance is not a guarantee of future results. Potential cash flow, potential returns and potential appreciation are not guaranteed. Securities offered through FNEX Capital, member FINRA, SIPC.