What is a Delaware Statutory Trust for Real Estate?
A Delaware Statutory Trust (“DST”) is a separate legal entity created as a trust under the laws of Delaware in which each owner has a “beneficial interest” in the DST for federal income tax purposes and is treated as owning an undivided fractional interest in the property.
A DST enables real estate investors to pool resources with other investors to acquire a larger real property asset than what would have been affordable on their own. Acquiring interests in several DSTs allow for greater diversity and risk management in a real estate investment portfolio.
How DST investing works
Typical DST properties are institutional grade commercial properties including apartment communities, office buildings, retail buildings, or shopping centers. The property sponsors (trustees of the DST) are real estate developers who purchase the property and structure it as a DST.
Investors purchase interests in the DST, which holds title to the property and guarantees the mortgage loan. Therefore, investment in the real estate is shared among many investors, who then have fractional ownership in the property.
DST vs. Tenants in Common
The key difference between a Tenants in Common (TIC) offering and a DST offering is that in a DST, the investors are not direct owners of the real estate; rather, they hold a percentage of beneficial ownership (beneficial interests) in the trust. In a TIC arrangement, all tenants hold an individual, undivided ownership interest in the property.
Lenders view the DST as the sole borrower and therefore, under a DST structure, property lenders can make one loan to one borrower ﹘ the DST. In a tenant in common structure, each investor has to qualify for his/her own pro-rata share of the mortgage. The IRS allows a maximum of 35 investors (borrowers) in a TIC; there is no limit for a DST.
In a DST, the investors’ only right with respect to the DST is to receive distributions and they have no voting authority; in a TIC, each tenant in common has equal voting rights regarding the property.
DSTs and 1031 Exchanges
In 2004, the IRS released Revenue Ruling 2004-86, which allows the use of a DST to acquire real estate where the beneficial interests qualify as 1031 exchange replacement properties (certain IRS restrictions apply). Deals structured as a DST have become more popular among 1031 exchange investors and sponsors due to tightening credit markets. Since the lender is making a loan to just one borrower, financing is more easily secured. In addition, it can be easier to attract more investors with lower minimum investment thresholds since, as noted above, the investors do not have to qualify for their pro-rate share of the mortgage.
Are you considering a DST investment?
If you are considering investment in a Delaware Statutory Trust, or have questions about the implications of this strategy on your overall tax situation, let’s talk. You can contact me at sfilip@KRScpas.com or (201) 655-7411.