Investing in a Delaware Statutory Trust is a common strategy for accredited investors, especially those undergoing 1031 exchanges that want to enjoy passive involvement. However, there are still plenty who have their misgivings and doubts regarding the safety of this investment. Are Delaware Statutory Trusts safe? If the sponsor and investors follow IRS rules, conduct due diligence, and plan ahead of time, they may offer certain investor protections. However, like all investments, they carry risks that should be carefully considered.
In this blog article, Realized 1031 discusses the various factors that affect the relative security of joining this investment. We’ll also discuss DST risks that you’ll want to keep in mind. Let’s dive in.
Legal and Regulatory Framework
Delaware Statutory Trusts (DSTs) operate under a defined legal structure that supports their use in 1031 exchange strategies. Their eligibility for tax deferral is based on compliance with IRS Revenue Ruling 2004-86, which outlines structural requirements the DST must follow—such as restrictions on active management and reinvestment of proceeds. As long as the investors and sponsors comply with these regulations and avoid committing the so-called “seven deadly sins,” the trust structure may remain eligible for 1031 exchange treatment. However, tax deferral is not guaranteed and may be subject to review by the IRS.
Another legal provision that offers limited liability of DSTs is how the structure limits personal liability for investors. If the property is unable to meet its financial obligations, the lender’s recourse is typically limited to the trust’s assets. Individuals have one more level of protection that prevents them from personal lawsuits or liability beyond the capital or investment they put into the trust.
DST Sponsor
One of the most important elements in a Delaware Statutory Trust (DST) investment is the sponsor. The structure only allows the sponsor to take primary responsibility of operations, administration, and day-to-day management of the DST property. The investors can’t take part in any property-level decision-making. As such, the competency of the sponsor will have a huge impact on the profitability and risk profile of the property and what investors will ultimately earn.
Due diligence is essential when it comes to choosing sponsors, not just the offerings. To increase safety and lower risk, you’ll want to evaluate sponsors based on the following metrics.
- Track Record: Ask for past DSTs the sponsor handled and the ROI they provided to investors. While past performance does not guarantee future outcomes, it can help assess how the sponsor has handled similar assets and market conditions.
- Experience: How long has the sponsor been working on DSTs? What is the scale of their past projects? Sponsors with extensive experience may be better equipped to manage complex assets or tenant relationships.
- Financial Stability: A financially sound sponsor is more likely to weather economic downturns and unforeseen challenges, ensuring the long-term stability of the DST.
Asset Quality
The quality of the DST property is, of course, a main determining factor when it comes to the investment’s risk and performance profile. Due diligence is also critical for the asset itself, allowing investors to see beyond what the private placement memorandum (PPM) is showing. Key characteristics to evaluate may include:
- Location stability and long-term demand
- Tenant quality and lease duration
- Asset class consistency with your risk tolerance and investment goals
Higher-quality assets with long-term leases and reliable tenant histories may help support more stable cash flow, though no DST investment is guaranteed. Alignment with your personal risk profile remains essential.
Delaware Statutory Trust Risks To Consider
While DSTs may offer tax deferral and passive income potential, they also carry specific risks that investors should carefully consider before committing capital. Understanding these challenges can help you prepare more thoroughly.
- Illiquidity: DSTs typically have holding periods that last anywhere between five to seven years. Those who may need liquid cash in the near future might find DSTs too restrictive.
- Market Risks: Like any other investment, DSTs are still exposed to market volatility, especially ones that affect the real estate industry.
- Economic Shifts: Rising interest rates or inflation may also reduce property performance or affect distributions.
- No Control: This characteristic may be appealing to investors who no longer want involvement in their investments. However, those who still want some level of control over income-generating strategies or capital improvements will find DSTs inflexible.
Wrapping Up: Are DSTs Safe?
Given the structure and legal protections of DSTs, these investments are structured to offer passive real estate exposure. Their design limits investor involvement and provides certain legal protections, such as limited personal liability. However, like all investments, DSTs carry risks—including illiquidity, market volatility, and sponsor-related performance concerns.
Working with a qualified sponsor and conducting due diligence on the property, lease structure, and offering documents can help investors make more informed decisions. Ultimately, understanding the structure, risks, and goals of the DST strategy is key before committing capital.
The tax and estate planning information offered by the advisor is general in nature. It is provided for informational purposes only and should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.
Article written by: Story Amplify. Story Amplify is a marketing agency that offers services such as copywriting across industries, including financial services, real estate investment services, and miscellaneous small businesses.
Sources:
https://www.irs.gov/pub/irs-drop/rr-04-86.pdf
https://www.nolo.com/legal-encyclopedia/what-is-private-placement-memorandum.html
https://smartasset.com/investing/delaware-statutory-trusts-dsts
