Delaware Statutory Trusts
A DST is a separate legal entity formed as a trust under Delaware law. If properly structured, the DST will be classified as a grantor trust for federal income tax purposes and, as a result, the purchaser of a beneficial interest in the trust will acquire an undivided interest in the asset(s) held by the DST. An investor can use a beneficial interest in a DST as replacement property in a 1031 tax deferred exchange.
A DST is structured so that each beneficiary (investor) owns a beneficial interest in the trust. The managing Trustee of the DST is either the Sponsor or an affiliate of the Sponsor.
The DST holds title to 100% of the interest in the property.
Tax reporting for a DST is done on a Schedule E utilizing property operating information provided by the Sponsor.
The IRS issued the Revenue Ruling 2004-86 that set forth parameters a DST must meet in order to be viewed as a grantor trust and qualify for a viable tax deferring vehicle. If the DST is structured responsibly, the parameters do not prohibit a successful business plan for a property. The following is a list of the parameters and the procedures generally accepted to comply with these limitations:
The DST may not purchase additional assets other than short-term obligations. All cash from the property is held in liquid money market type accounts.
The DST may not accept additional contributions of assets.
There can be no additional capital calls to the DST. As part of the due diligence, the Sponsor conservatively anticipates the amount needed to properly maintain the property over the holding period and that amount is included in the initial capital raise.
The DST may not renegotiate the loan terms and/or the loan may not be refinanced.
The Sponsor has negotiated the loan terms for the property prior to acquiring the property. In the event the property is not sold before the loan matures, there are provisions in place to convert the DST to a limited liability company (“Springing LLC”). This allows the
Trustee (Sponsor) the ability to take the necessary actions to remedy the situation if, for example, the property needed major capital improvements (not allowed within the DST structure) or the loan needed to be refinanced. This action will limit investors’ ability to conduct another 1031 exchange upon the sale of the property.
The DST may not renegotiate leases or enter into new leases. The investors, through the Trust Agreement, enter into a Master Lease with the Trustee in order to avoid having to renegotiate leases or enter into new leases with the actual tenants.
The DST may not make major structural changes. Any major improvements will be done or have been done by the seller prior to the Sponsor purchasing the property. Normal “turn-over” expenses fall within the DST guidelines and do not create an issue with the DST
structure. Diversification does not insure a profit or guarantee against a loss.
The DST must distribute all cash, other than the necessary reserves, to the beneficiaries.
The DST may not sell or exchange property and reinvest the proceeds.
The DST structure does allow for the investors or beneficial owners to conduct their own 1031 tax deferred exchange once the DST has liquidated its assets (i.e. sold the property).