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July 18, 2018

Deferring Gains on Real Estate Sales with a Delaware Statutory Trust

The real estate markets are continuing to have positive trends. With that in mind, many taxpayers are looking for ways to defer gains from real estate sales for income tax purposes through IRC §1031 like-kind exchanges (LKE).

Finding the right property within the allotted timeframe of a LKE can pose barriers to using this tax savings strategy. For those that find themselves in this situation, there may be a solution with the Delaware Statutory Trusts (DST).

What is a Delaware Statutory Trust?

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. In 2004, the IRS released Revenue Ruling 2004-86 which allows the use of a DST to acquire real estate where the beneficial interests in the trust will be treated as direct interests in replacement property for purposes of IRC §1031.

This is an important distinction because the IRC §1031 tax-deferred exchange code does not allow partnerships, such as an LLC or LLP, to hold interest in real property. In the DST, the real estate is owned by the trust, and the investors own their pro-rata shares of the trust. This makes the funds used to acquire the shares eligible for IRC §1031 tax-deferred treatment.

Advantages of a DST

  • Investors may either deposit their IRC §1031 exchange proceeds into the DST or investors may purchase an interest in the DST directly
  • Lower minimum investment from each investor – Most DST investments are assets that your small- to mid-sized accredited investors could not otherwise afford. By pooling money with other investors, they can acquire this type of asset
  • No IRS imposed limitation on how many investors can participate in one DST
  • Investors are not required to form single member LLC’s
  • Limited personal liability – If the trust fails, creditors would be limited to the assets of the trust, and unable to reach the personal assets of the investors
  • Because the trust is the borrower for any financing, financing is easier and less costly as each investor in the DST does not need to be qualified
  • Investors do not have to be involved with the operational or management control over the property
  • Generally structured and sold as securities and purchased through securities representative

Disadvantages of a DST

  • Once the offering is closed, there can be no future contributions to the DST by either current or new beneficiaries so the investment properties held within the DST must be able to support their own capital improvements and cash flow
  • Investments held by the DST are typically long-term investments – typically 2–10 year period and illiquid to investors
  • There are no voting rights nor is any operational or management control over the property allowed
  • The trustee cannot
    • Enter into new leases or renegotiate the current leases, unless there is a need due to a tenant bankruptcy or insolvency
    • Renegotiate the terms of the existing loans and cannot borrow any new funds from any party unless a loan default exists as a result of a tenant bankruptcy or insolvency
    • Reinvest the proceeds from the sale of its real estate
  • The trustee is limited to making capital expenditures with respect to the property for normal repair and maintenance, minor non-structural capital improvements, and those required by law

Though Delaware Statutory Trusts are not new, current tax laws have made them a potential solution for passive IRC §1031 exchange investors and direct (non- IRC §1031) investors alike.  If you are considering investing in a DST, contact an Anders advisor to assist you with identifying the advantages and disadvantages.

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