DST Properties for 1031 Exchanges

Why Are DSTs Such a Common 1031 Solution?

Fractional property investments through DSTs are an attractive option for many 1031 exchange investors and have been in extremely high demand over the last decade. Real estate owners seeking the tax deferral benefits of 1031 exchanges and avoiding day-to-day management responsibilities often appreciate the advantages of Delaware Statutory Trust (DST) co-ownership.  The DST property ownership structure allows the smaller investor to own a fractional interest in large, institutional quality and professionally managed commercial property. Small and large investors alike benefit from increased diversification over the typical NNN options. 

Suitable for 1031 Exchanges. In DST 1031 properties, each investor has an ownership interest in the Trust, which in turn owns the property.  The IRS treats the security owned by the DST investor as direct property ownership, thus qualifying for a 1031 exchange.  This came about in 2004, when the IRS released Revenue Ruling 2004-86, which allows the use of a DST to acquire real estate, where each owner in the trust will be treated as direct interests in replacement property for purposes of IRC Section 1031. 

Institutional GradeThanks to the co-ownership structure, DSTs offer lower minimum investment threshold amounts, providing smaller investors the benefits of owning institutional grade investment real estate such as multifamily apartment communities, medical office, office buildings, senior living facilities, student housing, self-storage facilities, industrial properties, national retail and service franchise locations and others. It used to be that only large institutional investors such as life insurance companies, pension funds, REITS and foundations were able to invest in these properties.  Now through a DST, individual investors have the ability to invest in a diversified selection of institutional quality properties that they could otherwise not purchase individually.

Professional Managment. DST’s are ideal for investment real estate owners who still want the returns associated with property ownership, but are tired of management responsibilities associated with individual real estate ownership.  DSTs are managed by professional real estate asset managers and property managers that are set in place by the sponsor.  The sponsor is the entity that packages the DST and makes it available to accredited investors as a non-traded security through independent broker dealers. 

DSTs do have their limitations and are generally best suited for investors seeking a longer-term, passive investment.  Here are some of the structural advantages and disadvantages of DSTs:

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Benefits

  • Low Minimums. With investments as low as $50,000, private investors have access to larger institutional-grade properties and tenants.
  • Cash Flow. Each owner receives their percentage share of cash flow income paid monthly (with most sponsors).
  • Professional Management. With professional property and asset management in place, DST investors don’t need to worry about day-to-day management responsibilities.
  • Real Estate Ownership.  Similar benefits to sole ownership including asset depreciation and interest deductions.
  • Diversification. DSTs offer additional asset and geographical diversification.
  • Limited Liability. The DST structure shield investors from personal liabilities beyond the amount of their investment.
  • Pre-packaged Investments. Quick closing since financing and all due diligence is in place, making it relatively simple for investors to use 1031 exchange funds to purchase one or more fractional, DST investments.
  • Single Borrower. The DST owns 100% of the property and serves as the sole borrower. This makes it easier and less expensive to obtain financing.
  • Control. Major decisions of a DST are made by a single Trustee, eliminating concerns or disagreements between investors.

Disadvantages

  • Lack of control. Investors do not have direct control of the property management or disposition and are dependent on the sponsor and manager. This is both a benefit and a disadvantage.
  • Illiquid. DSTs are considered an illiquid investment and have no established secondary market.
  • Income. Return is not guaranteed.
  • Refinance. The Trustee cannot renegotiate terms of existing loans nor borrow any new funds.