Real estate investments have been highly sought after by investors of all levels. Some investors live for the hustle and bustle that come with real estate investments and some investors are in it of the passive income. For the investors that like the idea of passive income, but hate the idea of managing a tenant, a Delaware Statutory Trust may be a viable option.
Delaware Statutory Trusts (commonly referred to as a “DSTs”) are often overlooked when talking about real estate investments, though they should not be. With low-risk and low-cost, DSTs are an excellent way for investors to hold real estate assets, create passive income and shield personal liability.
Before determining if a Delaware Statutory Trust is the right choice for you, there are some aspects of the DST worth considering.
You should never jump straight into an investment without fully understanding the implications. Let’s take a moment to understand the basics of a DST, the advantages, and the disadvantages.
What is a Delaware Statutory Trust?
A DST is a separate entity that is created as a trust under Delaware statutory law. In 2004, the IRS released a Revenue Ruling (2004-86) that recognized the DST as an investment trust and allowed a taxpayer to exchange real property for an interest in the trust without recognition of gain or loss under section 1031.
How does a Delaware Statutory Trust Work?
Real estate investors will create the trust under Delaware statutory law and then acquire any investment property to be held in the DST. The Trustee of the DST will open the trust up to investors who would like to purchase a beneficial interest in the trust. Investors can acquire a beneficial interest by either making a direct payment or by transferring 1031 exchange funds into the trust.
Advantages of a DST
There are many advantages to DSTs that lead investors to utilize them. It is important to know what benefits you will receive from using a DST.
The largest reason DSTs are popular with California investors is because they are exempt from the Franchise Tax. The Franchise Tax collects taxes on personal and corporate income. However, DSTs are classified as an estate planning tool, meaning they are not subject to the Franchise Tax.
Additionally, the structure of a DST means that it is not subject to capital gains taxes, either. Investment proceeds are rolled into a like-kind investment within a specific time frame, so the government does not see the proceeds as a gain.
A significant drawback for most real estate investment is the large amount of taxes that must be paid. DSTs are exempt from some of the more expensive taxes, saving investors’ money and guaranteeing a higher return on the investment.
In a DST, each asset is kept separate from you and your other assets. If an asset within the DST comes under attack, you will not face personal liability and your assets outside of the DST will not be subject to the creditors of the DST.
As mentioned above, when you utilize a DST as an investment vehicle you are limiting your personal liability regarding the assets held within the DST. This method allows the investor to be involved with quality real estate investments without worry about being sued over the property.
DSTs offer greater flexibility for real estate investment. The structure makes it infinitely scalable. When rolling over proceeds into a like-kind investment, investors can break into previously untouched markets that they may have been unable to access independently.
Additionally, there is no limit to the number of investors that can use a DST. While some trusts may cap the number of investors at 499, others have no restrictions.
The DST outlines the decision making within the trust agreement and all major decisions of the DST are made by the Managing Sponsor. This management structure allows the investor to take a passive role and not be burdened with the day-to-day minutiae of real estate investments. Essentially, the investor makes their capital contribution, leaves all the work up to someone else and draws on the profits of the DST.
Disadvantages of DSTs
While there are many benefits to using a DST for real estate investment, there are also drawbacks.
Loss of Control
DST investors do not retail any control over the management of their investment. This lack of control may make some investors uncomfortable.
Future Capital Contributions
Once, the offering period is closed, the DST cannot raise new money by capital contributions. A current investor who wishes to add more funds to the DST will be prohibited from doing so.
DSTs are an illiquid investment. If you face a situation where you need to liquidate your assets immediately, you would be unable to access your assets held in the DST.
DST investors should prepare to be involved for the entire life of the trust, usually between five and ten years. If you think you may face a situation that requires immediate liquidation, a DST is likely not the best option for you.
While the structure of DSTs is simple, the execution and details do become complicated. Between the passive role of investors, the anonymity, and the way that proceeds are rolled over into new investments, it is easy for DSTs to become complex very quickly.
The best way to avoid unnecessary complications is by choosing an attorney who regularly handles this type of transaction. Though you do not have control over investment decisions, you do choose who to hire to manage the DST.
Who Would Be a Good Fit for a DST?
There are certain types of investors that benefit more from a DST than others. Experienced real estate investors who prefer a hands-off approach or who are looking to exit real estate holdings without a capital gains tax may decide to use a DST over traditional investment methods. While they have the knowledge and expertise to invest independently, some investors would rather have a passive role in their investment management.
On the other end of the spectrum, DSTs are great for those new to real estate investing. DSTs offer exposure to the real estate market without the new investor needing to have the expertise required to actively manage the investment.
What Comes Next
With a better understanding of what Delaware Statutory Trusts are, you can decide for yourself if you should invest in one. While they have many benefits, there are also drawbacks to DSTs.
Before investing your time and money using a Delaware Statutory Trust, consult with an attorney to speak about all the aspects of your investment and trust structure. Sollertis is a law firm in San Diego, California, helping real estate investors and business owners with their efforts to grow their investments, and protect their wealth. The legal team at Sollertis combines superior expertise in this area and years of experience to ensure your protection.