The concept of real estate is straightforward. Simply defined, real estate describes tangible property that includes land and anything permanently attached to it or built on it. This includes improvements and buildings. Natural formations are also part of this definition. The trees fronting a rental home, landscaping that improves the look of an office building – all of this falls under the category of real property.
While the basic real estate definition is simple, that simplicity falls apart when discussing various types of ownership structures. These include joint tenancy, tenants in common, and sole ownership. Then there is the Delaware Statutory Trust (DST) and the limited liability corporation, or LLC.
DSTs and LLCs share one similarity – specifically, they can act as holding entities for real estate ownership. They can also protect investors against creditors.
But the way in which these entities manage real estate holdings and taxes is very different.
The Delaware Statutory Trust is a legal entity created as a trust under Delaware state laws. The trust, which is owned and operated by a sponsor or sponsors, acquires, manages, and sells real estate based on certain strategies. Then the sponsors seek out investors who acquire shares in the trust. While the trust owns the underlying property, the investors have a beneficial interest (and are known as the trust’s beneficiaries).
DSTs benefit investors in that they can provide passive income through real estate ownership without the headaches of ownership. Furthermore, DSTs can provide access to institutional real estate that might otherwise be out of reach of many investors. And the IRS recognizes DST interests as potential replacement properties as part of a 1031 exchange process.
DST investors receive a 1099 for income generated by the DST, which is then reported to the IRS via Schedule E.
LLCs can also buy, sell, and manage real estate. But these aren’t set up as trusts. Rather, the LLC is a business structure that combines a corporation’s limited liability with a partnership’s or sole proprietorship’s pass-through taxation. Investors use LLCs to purchase commercial properties to shield their personal assets from whatever might happen with those properties.
One LLC type is a series LLC. This consists of multiple LLCs under a single-parent LLC. These separate LLCs are controlled by their own members and remain separate from one another. It’s not uncommon for an “umbrella” LLC to oversee series LLCs that buy different real estate properties. Rather than owning shares of a trust, LLCs are set up to own a specific property or group of properties outright.
Because LLCs are pass-through entities, earnings go straight to owners, who pay taxes through personal income tax filings.
LLCs and DSTs can be useful structures in buying, managing, and selling real estate. But setting up such an entity – or participating as an investor – requires research and knowledge. As such, it’s a good idea to discuss the potential advantages and disadvantages of these structures with a tax professional and/or certified financial planner.