Deferring capital gains taxes by acquiring Delaware Statutory Trust (DST) shares through a 1031 exchange may provide tax-deferral benefits, though investment outcomes vary based on market conditions and individual circumstances. A DST allows you to invest the proceeds from your relinquished property into the trust. Your replacement property is ownership of fractional interests in the DST.
However, choosing the right DST offering is crucial for a potentially successful investment strategy. Evaluating offerings and properties is essential to selecting the DST that aligns with your risk tolerance, investment horizon, and desired investment return.
Finding and Analyzing the Offerings
Unlike commercial property listings, DST offerings are private investments, requiring you to work with a broker-dealer or RIA. Here’s what to consider when examining DST offerings.
Sponsor reputation and track record
The sponsor is the entity that structures the DST and uses it to purchase properties. The sponsor oversees the properties’ daily operations and decides on capital improvements. As such, the sponsor’s strategies, investment philosophy, and decisions play a major role in the profitability and risk profile of the DST.
Investors may consider evaluating the sponsor’s track record by reviewing its:
- Experience with real estate and DSTs
- Investment philosophy and strategy
- Performance history with previous offerings
Property factors
Analyzing the DST’s properties and investment potential is a good idea as part of your due diligence. Key areas for review include:
- Asset type: Investment real estate is a broad category that includes multifamily, storage, retail, hospitality, and more. A DST might specialize in one property type or have a diverse portfolio. Remember that asset performance is based on demand, economic issues, and other factors.
- Location: Geographic regions have unique characteristics that impact real estate performance. When studying a DST listing, research the market conditions of the property locations to determine if this fits your investment goals and risk tolerance.
- Tenant quality: In addition to analyzing property occupancy, examine the lease terms and tenant type. High-quality tenants with strong credit backgrounds are more desirable, while longer lease terms can suggest stability.
Property management and expertise
A property may look good on paper, but poor management can generate underperformance issues. Investors may consider evaluating the DST’s property management team to assess whether it has the experience to manage operations effectively and support long-term property performance.
Private Placement Memorandum (PPM)
The DST’s Private Placement Memorandum (PPM) contains a great deal of data. Take time to examine the document, which provides information such as the DST property’s general description, financial projections, fee structures, and possible risks.
Understanding Investment Terms and Fees
Understanding a DST's investment requirements, fees, and terms is just as important as analyzing its sponsorship history and property holdings. Key items to review include::
- Minimum investment requirements: The typical DST minimum investment requirement is $100,000, but can be as low as $25,000. If you’re targeting a DST as a replacement property for a 1031 exchange to fully defer taxes, invest all proceeds from the relinquished property sale to avoid triggering a potentially taxable event.
- Fee structure: DST sponsors earn money by charging fees to find, acquire, manage, and sell properties. Check the trust’s fee structure to ensure it’s reasonable based on the property’s projected income.
- Hold period: Ask the DST sponsor about typical property holding periods. Most DSTs are long-term investments, which means your cash might be tied up for five to ten years or longer.
- Projected returns: The PPM should indicate your DST investment's projected income and cash flow, though actual results may vary. Historical property performance may provide context, but does not guarantee future results.
- Exit strategy: The DST won’t own property forever; an exit strategy is required to dispose of the asset. Exit strategies can include selling the property or refinancing it for extended investment opportunities. There is no right exit strategy. However, the one used should fit your investment goals.
Knowing the Risks and Limitations
DSTs aren’t suitable for everyone. Even if an offering looks good on paper, there are inherent risks involved with the investment, including the following:
- Illiquidity: DSTs are illiquid investments; you can’t sell your interest quickly for cash. Additionally, few secondary markets exist where you can sell your shares. As a result, you can’t cash out until the sponsor performs its exit strategy.
- Loss of control: DSTs are passive investments. While you won’t take on the headaches of property management, you also don’t have input on the property’s financing or sale. All of these decisions are in the hands of the sponsor.
- Restrained capital: The DST can’t raise additional capital once the trust is closed to investors. This could mean a lack of available funding for major capital improvements or expenses, impacting your income or property appreciation.
Going the Extra Mile
DST offerings can provide viable investment opportunities for investors seeking a 1031 exchange replacement property, depending on individual financial goals and risk tolerance. However, involvement with a DST requires an in-depth analysis of listings, offerings, and other considerations. Before considering a DST, investors should carefully evaluate the associated benefits and risks.
Knowledgeable professionals can help you with the due diligence and investment processes. Realized 1031 has those professionals, and they’re ready to guide you through the process, from assessing DST offerings to investing in them.
Visit Realized 1031’s website at realized1031.com to set up a no-obligation consultation.
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.
