Delaware Statutory Trusts, explained

What a DST is

A Delaware Statutory Trust is a legal entity, formed under Delaware law, that holds title to real estate: often one large property, or a small portfolio, of a kind an individual investor would rarely buy alone.

A sponsor forms the trust, acquires the property, arranges any financing, and then sells beneficial interests in the trust to investors. The investors own the interests. A trustee holds the property under the terms of a trust agreement that deliberately gives it very little discretion. The sponsor or an affiliate typically manages the property day to day. Investors receive their share of whatever cash the property produces, and their share of the proceeds when the trust eventually sells.

Revenue Ruling 2004-86

In Rev. Rul. 2004-86, the IRS considered a DST whose trustee had no power to vary the investment. It concluded that such a trust is an investment trust under Treasury Regulation §301.7701-4(c), and that each holder is treated for federal tax purposes as owning an undivided fractional interest in the trust’s real property. That treatment is what allows a DST interest to serve as replacement property in a §1031 exchange, provided every other requirement of §1031 is met.

The ruling describes one fact pattern. The IRS does not review, approve or endorse individual trusts, and a trust that departs from the ruling’s conditions can lose the treatment it depends on.

Why some exchangers consider one

• Timing. A sponsor’s interests can usually be identified and closed within the exchange window, which is why some exchangers list one as a backup identification.
• Scale. A fractional interest in a larger property than the exchanger would buy directly.
• Passive ownership. No property management by the investor, by design.
• Sizing. Interests are sold in amounts that can be matched to leftover equity in an exchange.

Each of those has a cost, described below. Whether the trade is worth it is a question for your own financial, tax and legal advisors, not for a real estate licensee.

The risks

• Illiquidity. There is no public market for DST interests. An investor generally holds until the trust sells the property, on the sponsor’s timetable.
• Reliance on the sponsor and the tenants. The investor has no vote on operations and no ability to replace management. Income depends on tenants continuing to pay under arrangements the trust cannot change.
• Fees and load costs. Offering costs, sponsor fees and management fees are paid out of the money invested and the property’s cash flow; they are disclosed in the offering documents and should be read there.
• Loss of principal. The property can lose value, and debt at the trust level makes the equity more sensitive to that loss.
• The tax treatment may not be achieved. If the trust’s structure or operations fall outside Rev. Rul. 2004-86, or if the exchange fails on other grounds, the deferral can be lost.
• Concentration. One property, one tenant or one market can be a large share of an investor’s real estate holdings.

DST interests are securities

DST interests are generally offered as private-placement securities under Regulation D and sold by registered representatives of FINRA-member broker-dealers, typically only to accredited investors. The Securities and Exchange Commission’s current definition of accredited investor is published at sec.gov. Florida law (Chapter 517, Florida Statutes) requires anyone who sells or offers securities in the state to be registered with the Office of Financial Regulation, and it has no exemption for real estate licensees.

That is why the line drawn in the next section is a legal boundary rather than a preference.