Delaware Statutory Trusts (DSTs) are an increasingly popular investment vehicle for those seeking attractive passive investment opportunities. A sponsor creates a DST using Delaware’s unique trust regulations to design a pre-packaged offering for investors. DSTs often focus on specific real estate sectors and include assets that a typical investor could not purchase individually.
However, Delaware Statutory Trusts (DSTs) are not without their challenges, especially for investors planning 1031 exchanges. Rigorous regulations by both the IRS and Congress can pose significant hurdles. Compliance with these guidelines is crucial to avoid financial and legal penalties. Therefore, investors must diligently navigate these complex rules to ensure the validity of their 1031 exchanges involving DSTs, underscoring the importance of adequate planning and expert guidance.
Investors seeking to execute a 1031 exchange to defer capital gains taxes when selling an investment property may look to a DST to satisfy all or part of the required replacement investment. Because DSTs have flexible investment amounts in many cases, buying into one can meet the 1031 exchange requirements for replacement value. A DST may also provide ongoing income without ongoing property oversight.
Employing DST participation to complete a 1031 exchange requires the investor to meet specific IRS guidelines. Some of the potential downside considerations include:
Investors have no control over operations. DSTs are managed by professionals, and the sponsor makes all significant decisions. That may be an added attraction for some investors, but may frustrate others. DSTs have inherent risks that each investor should evaluate.
DSTs can’t raise additional capital. They have a specific, closed-end investment period. Once the offering is closed, the sponsor may not accept new investors or raise additional money. That means that income distribution may be disrupted if the portfolio properties need substantial capital spent on repairs or other expenses.
DST investments are illiquid. They have holding periods ranging from 5 to 10 years, and investors cannot retrieve their capital until the DST's planned termination arrives. Investors should consider whether they want to liquidate sooner as they evaluate a DST investment. Since DSTs lack a public market for divestiture, investors can’t count on being able to sell their shares before the planned termination. Furthermore, some offerings restrict resale, limiting the potential for an early exit.
DST investments may include high fees. Compared to direct ownership, participation in a DST may involve higher upfront and ongoing fees. A DST sponsor may charge fees for selling commissions, broker-dealer expenses, and management costs such as property acquisition and disposition.
DSTs offer significant potential benefits, including income, 1031 exchange eligibility, portfolio diversification, and asset appreciation. The availability of DSTs as vehicles for 1031 exchange completion can be attractive. Investors should carefully weigh the pros and cons to decide if the investment suits their circumstances.