HOW 1031

DSTs offer investors a much simpler means of achieving the tax benefits of a 1031 exchange, along with several other significant potential advantages not inherent in a traditional exchange.

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Delaware Statutory Trusts (DSTs) offer a variety of unique potential benefits that make them highly attractive to a wide variety of accredited investors. Chief among these benefits is the fact that they satisfy the “like-kind” provision of §IRC 1031, allowing investors who have recently sold an investment property to defer capital gains tax by reinvesting those proceeds in a DST. Furthermore, DSTs provide a much simpler investment experience than a traditional “whole-property” 1031 exchange, which is often highly challenging to execute. DSTs also provide other significant benefits that a traditional 1031 exchange does not.


A DST is a legal entity created under Delaware statutory law for the purposes of fractional ownership in real estate investment properties.

The most attractive feature of DSTs for most investors is the fact that they qualify for preferential tax treatment under §IRC 1031 — commonly known as a “1031 exchange.”


Pursuant to §IRC 1031, any investor who sells investment property and reinvests the proceeds from that sale in a DST in a timely manner can defer any capital gains taxes related to the proceeds from the disposed property.


As a fractional ownership model, DSTs offer investors proportional interest in the DST property (or properties) based on their percentage of ownership. DST investors receive monthly distributions (passive income) from the investment as well as proceeds from the eventual sale of the property when the DST runs its course.*


Most DSTs have a holding time of around 7-10 years before the property is put on the market.


Importantly, fractional ownership in a DST is treated by the IRS the same way as full ownership of an investment property, allowing for the capital gains tax deferral associated with a 1031 exchange (as mentioned above), along with other significant tax incentives.


Up to 499 investors can hold interest in a single DST, which means that investment minimums are relatively low, making DST investment very accessible for the average accredited investor.

Though DSTs offer the same tax incentives as a traditional whole-property 1031 exchange, they also offer additional benefits that make them a superior option for many investors.


The stipulation in §IRC 1031 for replacing a disposed property with a “like-kind” property is perhaps the most misunderstood provision of the legislation.

Many investors believe this means you must replace your current property with a real estate asset that is closely related in terms of asset class, quality, and/or use.


As an example, many investors believe that if they currently hold a multifamily residential property, then upon sale it must be exchanged for another multifamily residential property.


In reality, the like-kind provision is much more broadly construed, encompassing essentially any real estate property, including undeveloped land.


So for example, an investor can exchange a multifamily property for a commercial real estate asset, a single family home, or even a plot of vacant land and still satisfy the like- kind requirement.


Because of this broad definition, investors have a plethora of options for investment in different property types via DSTs, allowing for more selectivity as well as a greater potential for diversification.


As mentioned above, there are several key aspects of DSTs that make them a more attractive choice for most investors than the traditional “whole-property” 1031 exchange.

1031 time constraints and other challenges:


The traditional 1031 exchange can be extraordinarily difficult and stressful
to pull off successfully for a number of reasons, starting with the time constraints.


Investors seeking to execute a 1031 exchange have 45 days from the date of sale
to identify up to three potential properties for replacement, and 180 days from the date of sale to close on the property (or properties). These days are strictly construed, including weekends and holidays.


Other challenges that investors face include:

  • Limited supply of suitable property for exchange

  • Quality of available property (i.e., even if it meets the stipulations of 1031 exchange,

    is it a good investment?)

  • Difficulties closing (especially in a supply-constrained, highly-competitive real

    estate market)


As a result, many investors are hesitant to sell for fear of: 1) failing to successfully execute a 1031 exchange and being stuck with a large tax bill for the sale; or 2) executing a 1031 exchange and ending up with a less desirable property.


DSTs completely alleviate the above issues for the investor. All DST properties have already been vetted, diligence and closed by the DST’s sponsor.


As an investor, you simply choose from an inventory of ready properties, and your investment is closed and finalized in a matter of days. This eliminates the worry about missing deadlines due to complications in the process of identifying or closing on an appropriate property.


DSTs are a 100% passive vehicle from the perspective of the investor. All management of the property is handled by the sponsor, including day-to-day decisions and the eventual sale of the property.


This makes DSTs an especially attractive investment for seniors interested in exchanging investment property they are currently managing themselves for a passive, potentially income-generating investment.


The lower investment minimums made possible by the fractional ownership model (DSTs allow up to 499 investors) means that the typical accredited investor has access to a much higher quality of real estate than they would have the resources on hand to invest in through a traditional 1031 exchange.


Investors have the option to allocate their investment capital across as many separate DSTs as they wish (subject of course to meeting individual DSTs’ investment minimums).


This allows the investor to diversify their holdings while still meeting the requirements for 1031 tax treatment.


In addition, some DSTs hold multiple properties, so an investor may achieve some level of diversification even by investing in a single DST.


If a DST property is leveraged — that is, if the property’s purchase is financed using debt — the sponsor takes on all liability for the debt.

As an investor, that means there is no need to form an LLC to protect yourself against default, and you will never have to pay off any debt from a foreclosure.


When a DST reaches the end of its holding period and the property is put on the market, as an investor you have the option to reinvest any proceeds from this sale into a new DST, allowing you to continue deferring capital gains taxes related to both the

original property and the DST.

In fact, there is no limit on the number of times you can do this. Most DST investors elect to continue reinvesting their sale proceeds into new DSTs, effectively deferring capital gains taxes indefinitely.

This can lead to eventual tax forgiveness when the investor passes away. At this point the investor’s heirs receive a full step-up in tax basis, allowing them to sell the investment.


Even if an investor for some reason wishes to execute a traditional “whole-property” 1031 exchange (for instance, if they want to retain full control over their investment), it is often highly advantageous to work with an advisor that has access to DSTs for two basic reasons.

To begin with, DSTs offer a bulletproof backup plan in case the investor cannot identify suitable exchange property within the mandated 45-day window. In this case, the investor can still achieve full deferral of capital gains taxes by investing in a DST instead.

The second reason involves situations where a suitable property is identified for exchange, but its total value is lower than the disposed property or it doesn’t fulfill the debt-replacement obligation of §IRC 1031. In such a case, the excess proceeds from the original sale can be invested in a DST, assuring the investor receives the full tax deferral benefit.