DSTs Present Opportunities for Obtaining Replacement Properties in a Tight Market
One of the primary obstacles investors face in a 1031 Exchange is locating replacement property in a timely fashion. One possible solution is to acquire a fractionalized ownership interest in a Delaware Statutory Trust (“DST”). When structured properly under IRS Revenue Ruling 200486, a DST enables investors to acquire “beneficial interests” in the trust so that they are treated as possessing undivided fractional interests in the underlying property. A DST can therefore qualify as viable replacement property in an exchange and is appealing to investors who are comfortable owning a passive interest in a managed real estate investment. Here are several situations where a DST might constitute an attractive investment strategy:
When an investor desires ownership in high grade institutional property but lacks the financial wherewithal to purchase the property entirely on his own;
When an investor wants a pre-packaged replacement property where the financing is in place and the sponsor has already performed all necessary due diligence;
As a reliable backup on the list of identified properties;
where the investor has not used all proceeds from the sale of the relinquished property but still wishes to invest those funds and achieve a full tax deferral.
How does a DST work?
A DST ownership interest represents an indirect way of owning real estate and can be used to defer taxes in a 1031 exchange if it is structured in accordance with Revenue Ruling 2004-86. The trustee of the DST initially purchases, and holds title to, the property. A sponsor structures the investment, secures financing, coordinates property management and arranges for the issuance of beneficial interests in the DST, which can include up to 499 investors. The sponsor further provides investors with a Private Placement Memorandum (“PPM”). The PPM provides property information, financial projections, disclosures, area demographics, tenants and leases, along with information about the sponsor. Although treated as a security under federal securities laws, a DST interest is deemed real estate under Section 1031 when properly structured.
Benefits of Ownership under a DST
There are many advantages of a DST especially when compared to a traditional tenant in common program (“TIC”): Some of the main advantages are as follows:
1. A DST is not limited like a TIC to 35 investors-this allows the cost to be spread among more investors so that smaller investors can exchange into a DST. 2. Many DST sponsors can match the amount to be invested into the DST with the net amount received for the relinquished property so investors can balance the equities and meet the necessary 1031 exchange requirements. 3. A DST allows for an efficient closing process with only one loan-investors don’t have to apply, or qualify, for the loan and there is no personal liability. 4. DST investors have no property management responsibilities. 5. A Properly structured DST qualifies as a valid form of 1031 replacement property 6. A DST has fewer roadblocks than a traditional TIC and can be sold to accredited investors without bank approval.
As always, PEAK1031 is here to assist you with all of your 1031 exchange needs and questions. *Peak 1031 Exchange, Inc. does not provide legal or tax advice. Always consult with your attorney or tax adviser.