Delaware Statutory Trusts (or DSTs) have become popular, offering advantages like capital gains tax deferral and passive income. As such, more and more investors now want to learn about this investment vehicle’s relatively complex ownership structure.
This blog post discusses in detail the DST ownership structure to help you gain a better understanding of how it works. We will also discuss the key players and how DST structures compare to other options in 1031 exchanges. Keep reading to learn more.
The Key Players of a DST Structure
A DST is a legal entity — specifically a trust — that owns investment property. Investors, on the other hand, own fractional interest in the DST and earn income from the property’s operations. In this arrangement, there are three main players.
DST Sponsor
The sponsor is the company that finds and acquires properties. It is also responsible for marketing the property and making offers to investors who may want to join the DST.
Trustee
The trustee is the owner of the DST, holding the title and acting as a fiduciary for the investors (beneficiaries). In addition, the trustee is responsible for overseeing that the DST operates within the terms set forth in the trust agreement. The DST sponsor can serve as the trustee in most cases.
Beneficiary
The investor is the trust’s beneficiary — they hold no control over property operations, potentially earning income from the asset’s appreciation, rent, and other sources of profit.
Control of a DST
The IRS Revenue Ruling 2004-86 enforces strict limitations on the involvement of investors in a DST. If you’re a beneficiary, you’re restricted from participating in the following aspects of property operations:
- Day-to-day property management
- Lease negotiations or terminations
- Selling or refinancing the property
It’s the sponsor and trustee that has the most control over the investment property. The former has the most significant role in the DST, responsible for day-to-day management. These tasks include management of tenants, addressing maintenance issues, as well as capital improvements.
On the other hand, the trustee oversees compliance with the terms set in the trust. Specifically, the trustee monitors the sponsor’s actions to confirm adherence to legal and fiduciary obligations, providing an additional safeguard for investors.
Comparing DST Ownership Structures to Other Investment Methods
In 1031 exchanges, many types of ownership structures are available based on your needs and preferences. DSTs are known for their lack of active involvement, making them ideal for those who want a potentially truly passive income source while deferring capital gains taxes. However, there are other options you can try.
The first is the traditional 1031 exchange. In this arrangement, you are in full control of the acquired property since you exchanged it for the proceeds of the relinquished real estate asset. As the direct owner, you are in charge of daily operations and management, giving you complete control over lease agreements, maintenance costs, and other aspects of owning an investment property. A traditional 1031 exchange is thus ideal for investors who still prefer active involvement over the property, especially risky assets that need a decisive hand.
Another common ownership structure is the NNN property, also called triple-net properties. These assets have the NNN lease agreement, which stands for the three net operating expenses: property taxes, insurance, and maintenance costs. In this ownership structure, the tenant is responsible for the three net operating costs. This approach allows investors to have a more passive role in property operations and management. Even so, the property owner may still be responsible for expenses like capital improvements and major structural repairs, giving them some level of control over the property.
Is There a Way To Control the Property in a DST as an Investor?
There is, in theory, a way to still remain in control of the DST property instead of only the trust: creating your own DST sponsor company and overseeing its operations. However, many investors refrain from this course of action for two reasons.
- Legal and Administrative Complexity: Establishing a DST sponsor company is in itself a complex undertaking. There are various legal processes involved, which may potentially heighten the chances of inaccuracies that disqualify you from tax-deferred status.
- Too Much Effort for a Few Benefits: The main appeal of DSTs is offering tax deferral and passive income. You can achieve these benefits through other investment methods. If you do choose to create your own DST sponsorship company, the effort may outweigh the potential advantages of the trust.
Wrapping Up: Understanding the DST Ownership Structure
DSTs are a popular investment vehicle where the sponsor and trustee have the most control over the real estate asset. The investors, who are the beneficiaries, don’t have an active role and simply enjoy the income from the property’s operations and appreciation. So, if you’re a 1031 exchange investor who wants less hands-on involvement in your next investment, entering a DST may be the ideal option for you.
If you want to learn more about DSTs and pertinent topics, Realized 1031 is here to help. Reach out to us today and let’s schedule an appointment.
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.
Sources:
https://www.delawareinc.com/blog/what-is-a-delaware-statutory-trust/
https://www.investopedia.com/terms/f/fractionalownership.asp
https://www.investopedia.com/terms/f/fractionalownership.asp
