DSTs and REITs both manage property for investors, but there are differences between them. They have very different structures with different operating mandates. Maybe another question is why an investor would want their DST to become a REIT. This is actually a valid question. Let’s answer this question and dig into the differences between these two investment vehicles.
DST Versus REIT
Before we answer the question, can a DST be a REIT? Let’s first look at what each is and their differences.
A DST is a Delaware Statutory Trust. It is a trust that holds real property. A DST's investors benefit from holding real property without the management. These benefits include tax deductions such as depreciation expense.
DSTs are illiquid since most require holding periods of 5-10 years. A special feature of DSTs is that they are 1031 exchange eligible. Investors can 1031 exchange into a DST that holds a single property or get diversification by exchanging into a DST with multiple properties.
A REIT is a Real Estate Investment Trust. Generally, REITs are structured as corporations. Like a DST, they hold real property but are more active in buying and selling those properties. REITs can be private or public, where they trade on public exchanges.
REITs don't provide the same tax benefits as DSTs. However, some do have qualified dividends.
Unfortunately for REITs, they are not 1031 exchange eligible. This is because exchanging from real property to a REIT is not "like-kind." However, investors wanting to utilize a 1031 exchange with a REIT can go about through a more elaborate path involving a 721 exchange.
To complete this exchange, investors 1031 exchange their real property into a DST. Then, the DST utilizes (after a two-year holding period) the 721 exchange into a UPREIT (Umbrella Partnership Real Estate Investment Trust). The UPREIT is an entity within the REIT. This transaction exchanges DST’s interests for operating partnership units in the UPREIT.
The advantage of the UPREIT over a DST is liquidity. The investor can sell those shares by converting operating units of the UPREIT into REIT shares. However, once an investor does a 721 exchange, they've done their last tax-deferred exchange. They have to hold their operating units indefinitely to keep the tax deferral.
Converting the operating units into REIT shares will allow the investor to sell those shares, providing liquidity in the process. Once the operating units are converted into REIT shares, a taxable event is triggered as all of the investor's deferred gains are now taxed. For that reason, many investors choose to sell their REIT shares almost immediately.
Can a DST Be a REIT?
Because each entity has a different legal structure and operating agreements, a DST can not be a REIT and vice versa. REITs are required to distribute at least 90% of their income as dividends. DSTs do not have any such requirement. REITs can also sell properties anytime, while DSTs generally hold properties for years. The DST dissolves once those properties are sold, whereas REITs can continue operating after selling a property.
But as we have seen, deferred gains can find their way from a DST to a REIT via a 721 exchange. In a way, one could say that the DST has become a REIT, though that is technically incorrect.
A 721 exchange is a complex process. Finding an experienced attorney or real estate firm who can answer your 721 exchange questions and complete the process if necessary is critical to ensuring a smooth transaction.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
Costs associated with a 1031 transaction may impact investor’s returns and may outweigh the tax benefits. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.
No public market currently exists, and one may never exist. DST programs are speculative and suitable only for Accredited Investors who do not anticipate a need for liquidity or can afford to lose their entire investment.
The actual amount and timing of distributions paid by programs is not guaranteed and may vary. There is no guarantee that investors will receive distributions or a return of their capital. These programs can give no assurance that it will be able to pay or maintain distributions, or that distributions will increase over time.
A REIT is a security that sells like a stock on the major exchanges and invests in real estate directly, either through properties or mortgages.
REITs receive special tax considerations and typically offer investors high yields, as well as a highly liquid method of investing in real estate.
There are risks associated with these types of investments and include but are not limited to the following:
- Typically, no secondary market exists for the security listed above.
- Potential difficulty discerning between routine interest payments and principal repayment.
- Redemption price of a REIT may be worth more or less than the original price paid.
- Value of the shares in the trust will fluctuate with the portfolio of underlying real estate.
- There is no guarantee you will receive any income.
- Involves risks such as refinancing in the real estate industry, interest rates, availability of mortgage funds, operating expenses, cost of insurance, lease terminations, potential economic and regulatory changes.
This is neither an offer to sell nor a solicitation or an offer to buy the securities described herein. The offering is made only by the Prospectus.
