Andrew Carnaby's statement that 90% of millionaires build their wealth from real estate has become famous over time. Said at the turn of the century, this insight still holds true today.
However, back in the late 1800s, things were a little different. There was no capital gains tax for one, as this was only instituted in 1913.
Of course, capital gains tax or not, real estate is still a promising investment type. What's more, capital gains tax can be minimized through informed tax planning strategies. The use of DSTs is one example of this.
But what is a DST? DST stands for Delaware statuary trust, and we are about to share with you how they work, as well as how they can qualify as 1031 exchange property.
If you are looking into liquidating your real estate assets for reinvestment purposes, we advise you to continue reading to find out more about DSTs and 1031 property exchanges.
What Is a DST?
A Delaware statuary trust or DST is a legal entity designed for the purpose of conducting business activity. Contrary to its name, Delaware statuary trusts are not registered exclusively in Delaware.
DSTs are also known in some instances as unincorporated business trusts or UBOs.
Similar to LLCs, DSTs are pass-through entities. This means they are not taxed on income generated.
Instead, the tax liability is passed through to the trustees. However, as a legal entity, DSTs do provide trustees and beneficial owners with limited liability.
Do DSTs Quality as 1031 Exchange Property?
If you are curious to know whether a DST investment can fall as like-kind property for a 1031 exchange, the answer is yes.
Although DSTs have been around since the '80s, they have recently become popular structures for the purpose of reinvestment of real estate proceeds. The reason for this is that DSTs can qualify as 1031 exchange property. Investors should keep in mind that DST's are only suitable for Accredited Investors and one must qualify as an accredited investor to participate in these programs.
1031 Exchanges Explained
If you are unfamiliar with 1031 exchanges, let's quickly take a look at how they work and what their requirements are.
In a nutshell, 1031 exchanges allow for real estate property to be sold without attracting immediate capital gains tax. Any applicable capital gains tax is deferred, allowing investors to enhance the growth potential of their portfolios. A further benefit is properties purchased through a 1031 exchange can be passed down to heirs tax-free.
However, there are a number of requirements for 1031 exchanges. These include:
- Proceeds from the sale of the real estate have to be reinvested in "like-kind" replacement property (properties that are considered similar)
- The replacement property or properties have to be identified within 45 days from the sale of the previously held property
- The replacement property or properties need to be successfully closed on within 180 days
- Replacement property has to be utilized for investment purposes or business purposes
The requirements for 1031 exchanges can often prove onerous for investors. Identifying qualifying replacement property, conducting due diligence on the property, and closing on it, within the required time frames can be difficult.
DST investments can however remove some of the obstacles involved in a 1031 exchange.
Let's take a look at some of the pros and cons associated with DST property investment.
Pros and Cons of 1031 Exchanges via DST Properties
DST investments are becoming increasingly sought after thanks to the fact that they can facilitate 3031 exchanges and the tax benefits that come from these. Besides the tax shelter that DST property investments can provide, they also pose a few other concrete advantages.
At the same time, not all investors may find DSTs property ideal. Below are the pros and cons investors should be aware of when considering DST property.
DST Investment Pros
DST property investment poses a number of advantages. DST investors can enjoy the benefits of 1031 exchanges, with fewer hurdles, and minimized risk of exchange failure. DST property investment allows for enhanced diversification and reduced personal management duties.
Streamlined 1031 Exchanges
The overarching benefit of DST investments is that 1031 exchanges can be accomplished in a streamlined manner, providing that the DST investors find a properly structured DST product.
When investing in a well-managed DST, investors can enjoy the tax shelter of a 1031 exchange, without the legwork of identifying, investigating, and closing on qualifying properties. Without the pre-established framework of a DST investment, investors run the risk of disqualifying their 1031 return due to factors outside of their control.
Zero Property Management Duties
Properties that are owned by DSTs are typically managed in full. This means that DST investors enjoy monthly income from their investment, without the need for hands-on management.
Property management can be a significant drawback of real estate ownership. Dealing with tenants and property maintenance can be a full-time job in and of itself.
With structured DSTs, investors do not have to worry about this aspect. Instead, all property management tasks are handled by the trust.
Opportunity for Portfolio Diversification
Another benefit of DST properties is the entry point for DST investment can be significantly lower than when buying total ownership of a property.
DST investments often consist of multifamily assets, mixed-used property, office space, and CRE assets. These types of real estate assets are often out of reach for private investors. DST investments, on the other hand, typically start at a minimum value of $100,000.
This means that DST investors can buy into a property with less capital. This also facilitates diversification, where buyers can choose to invest multiple properties types simultaneously.
DST Property Cons
While investing in DST 1031 property has many advantages, there are also several potential cons. These include a loss of control, illiquidity, market and financing risks.
Loss of Control
For some investors, having full property management might not be ideal. Thanks to the structure of DSTs, investors are not able to manage the affairs of the real estate investment.
In many cases, this can be a substantial bonus. However, if investors disagree on the way property management is carried out, this can become a point of conflict.
Another potential drawback to investing in DST property is its illiquid nature. DST property is normally only sold once the DST has completed its cycle, and there is no public market for ownership interests.
In some situations, an investor may be able to sell early. However, this is not guaranteed.
Therefore, DSTs investments are only suitable if you are looking to invest for long-term gain; typically over 5-10 years.
DST's or Delaware Statutory Trusts are real estate investments and therefore subject to all the risk related to real estate ownership. Some of these include occupancy, local employment base, rent collections, general economic risk, etc.
DST's usually employ the use of leverage to help investors meet their 1031 loan replacement requirements. Whenever leverage is part of a real estate purchase, it opens up the property to a potential foreclosure if at some point the property cannot generate enough net income to make ongoing loan payments.
Would You Like to Know More About DST Investments?
Now that you know the answer to "what is a DST," are you interested in learning more about potential DST investments?
If so, you have come to the right place. We specialize in DST property and real estate investment and are here to help you with your alternative investment journey. Do your portfolio a favor and find out more about our DST investment offerings.
We pride ourselves in providing open and honest investment information and opportunities that facilitate our clients' financial freedom. If you have any questions about DST investing, please do not hesitate to reach out and we will be happy to assist you.