Delaware legal trusts

A Delaware legal trust (commonly known as a DST) is, as the name suggests, a legal entity created as a trust under the law of the state of Delaware. A DST is created for real estate investment purposes and is especially useful on a 1031 exchange.

Under a DST, each investor owns a prorated share of the DST itself. The DST, in turn, holds title to various real estate interests and distributes the income received from the properties (either through rental income or the sale of the property) to investors in proportion to their share in the DST. .

The DST, through its signatory trustee, makes all decisions related to any property in the trust, releasing investors from this responsibility. One important thing to note about a DST is that the trust is not considered a taxable entity, so any profit or loss is passed on to the trust’s investors.

When it comes to 1031 exchanges, the IRS has determined that any beneficial interest in the DST is treated as identical to a direct interest in real estate. This means that properties held by DST fully qualify for 1031 exchanges, as long as the other requirements of that exchange are also met.

For investors who are not looking for day-to-day management responsibility and decision-making authority related to real estate, a DST can be an excellent option.

Benefits of a DST

One of the main reasons investors are so interested in acquiring a stake in a DST is the benefit of owning securitized real estate. However, a DST also offers other benefits to investors.

Eliminates the requirement for unanimous approval

Unlike a Tenancy-In-Common (TIC) ownership structure, a DST does not require the unanimous approval of all investors to make decisions regarding the real estate that is owned. For example, if the economic environment requires the prompt sale of a parcel of real estate held by DST, the authority to make decisions to list or sell the property rests with the DST signatory trustee and not with the investors themselves.

Limited personal liability

Due to each DST’s “remote bankruptcy” provision, individual investors enjoy limited liability for their personal assets. If the DST fails and you go bankrupt, the greatest risk for any individual investor is their investment in the trust. Trust creditors are limited to accessing any other assets of any investor.

Simplified financing

For the purposes of financing DST purchases, lenders treat DST as a single borrower (rather than looking at each and every individual investor). This makes financing easier and less expensive to obtain. Also, because the individual investor is not subject to a credit assessment, their individual credit rating is not affected by participation in a DST.

Loan exemption requirements removed

Since a DST investor’s rights are limited to receiving only distributions and the investor has no voting authority related to day-to-day operations, the investor fraud exclusions are removed for individual investors. Any lender will only look to the signing or sponsoring trustee for these exception provisions.

Lowest minimum investment

A DST is allowed up to 499 individual investors, which allows the minimum investment amounts to be much lower than with a TIC (which only allows up to 35). This allows investors with less to invest to continue to participate in a shared ownership strategy for real estate investments.

Risks of a daylight saving time

A DST offers the investor many benefits not found in other types of jointly owned real estate investments. However, DSTs are not without risk, like any other investment.

One of the biggest risks to consider is reliance on a program sponsor to manage the investment. Unlike a Tenancy-In-Common (TIC) where individual investors have a direct say, investors in a DST cede day-to-day decision-making authority to the program sponsor. This means that if the program sponsor makes reckless decisions or becomes insolvent, the DST could fail without any significant input from individual investors.

Also, as with any investment, there are tax-related risks associated with using a DST for the purposes of a 1031 exchange. While DSTs are often ideal for this purpose, there are no guarantees when it comes to the IRS. There is always the possibility that the IRS will not approve the DST structure or a particular 1031 exchange.

While the benefits of a DST tend to outweigh the risks, it is wise to have a complete understanding of both when deciding whether to participate in a DST.