Many investors use their investment properties as collateral for loans, helping them secure better rates or larger sums for new ventures and other financial needs. If you have DST investments, you might also be wondering if you can leverage them when trying to obtain financing. Can you use DST investments as collateral for loans? The answer is no.
While the DST entity itself often utilizes loans to finance its real estate acquisitions, individual investor interests in a DST are generally not directly pledgeable as collateral for personal loans. Below, Realized 1031 shares the reason why.
The Structure of DSTs
To understand why you cannot use interests as DST collateral, we must first examine the structure of this investment vehicle. When you purchase or acquire interests (through a 1031 exchange, for example), you’re buying beneficial interests. There is no direct ownership of the underlying real estate assets.
You must also understand that DSTs are often acquired with pre-arranged, non-recourse financing. The loan is secured by the property itself, and lenders cannot pursue individual investors in case the DST cannot meet financial or debt obligations. The sponsor, serving as the trustee, handles loan management and responsibilities as well, insulating investors from the complexities of debt servicing.
For DSTs that are eligible in 1031 exchanges, additional rules must be followed to maintain the tax-deferral status, as outlined in Revenue Ruling 2004-86. One of the so-called seven deadly sins prohibits DSTs from renegotiating existing DST loans after the offer is closed. This rule limits the ability to use the underlying property as fresh collateral for a new loan after your investment.
DSTs Cannot Be Used as Loan Collateral
You cannot use your DST interests as loan collateral in a traditional sense. The non-recourse nature of DST 1013 loans means lenders cannot come after your personal assets if you default. Plus, since you don’t own any of the underlying properties, you cannot unilaterally decide to encumber the assets with a new loan.
There’s also the fact that the DST interests themselves are tied in a holding period, making them illiquid. Lenders prefer collateral that can be easily liquidated if you default.
DST Investment Collateral Alternatives
Given how DST interests are disallowed as collateral due to the very nature of a DST, you must find other alternatives to secure financing. Here are some options you can explore.
- Portfolio Loans/Securities-Backed Loans: For investors who already have a diversified portfolio, you can explore portfolio loans, which are secured by your overall investment holdings. DST assets still won’t qualify, but the presence of other, more liquid assets could improve your borrowing capacity.
- Private Financing: Some private lenders may offer portfolio-based lending, considering the DST interests are part of the overall financial picture, even though they won’t be pledged as collateral.
- Alternative Collateral: Lenders also accept life insurance policies, real estate equity, and other types of securities as collateral.
Wrapping Up: DST 1031 Collateral Eligibility
You cannot use DST investments as collateral for loans. Given the structure of the DST, wherein you own beneficial interest instead of direct ownership, you cannot leverage the underlying properties as collateral. DSTs that qualify for 1031 exchanges are also under strict rules that ban loan renegotiations after closing the offering. Using the properties as collateral puts the tax-deferred status of the DST in jeopardy, potentially leading to a taxable event for all investors in the trust.
There are alternatives to try, especially if you already have a robust portfolio with other types of assets. Make sure to consult with your financial advisor or a tax expert when exploring your options.
Sources:
https://www.investopedia.com/terms/s/securitiesbased-lending.asp
https://www.irs.gov/pub/irs-drop/rr-04-86.pdf
https://smartasset.com/investing/delaware-statutory-trusts-dsts
