Real estate remains a widely used investment option due to its perceived relative stability and the range of market sectors available. However, many investors maintain portfolios made up primarily of traditional, directly owned real estate. This concentration can introduce increased risk exposure and often requires ongoing, active management. For those seeking broader diversification or reduced management demands, alternative structures may be worth considering.
One of these strategies is a Delaware Statutory Trust (DST), which may address several of these challenges while contributing to portfolio diversification. In this article, Realized 1031 shares how DSTs might complement a traditional real estate portfolio. Keep reading to learn more.
DSTs are an investment vehicle that owns one or more underlying properties with a goal of generating income. Investors own fractional interests in the trust by contributing funds. As the asset earns income through rent and other activities, the investors may receive dividends distributed.
Pursuant to Revenue Ruling 2004-86, DSTs may also be eligible to qualify for like-kind treatment under Section 1031. You can use the proceeds from the sale of your relinquished property to acquire fractional interests in a DST. You’d be able to potentially defer recognition of capital gains taxes, subject to IRS rules and timelines.
It’s important to remember that investors have little control over the operations and management of the DST’s underlying properties. Management responsibilities lie with the sponsor of the trust. This structure can provide a passive ownership experience, which may appeal to those seeking reduced involvement in real estate operations.
While traditional real estate investing has long been used to pursue long-term financial goals, it also presents certain limitations. Many investors who’ve built portfolios of single-family rentals, small multifamily properties, or commercial buildings eventually face drawbacks that can limit flexibility and growth. These issues often become even more prominent as investors age or look to transition into more passive forms of income. Common challenges associated with traditional real estate ownership include:
Delaware Statutory Trusts (DSTs) may help address some of these issues when incorporated into a broader real estate strategy. By shifting some holdings to a DST structure, investors may be able to reduce active management burdens, access new markets through diversified assets, and streamline estate-related considerations. The potential for regular income distributions and fractional ownership also allows for a more passive investment experience. Suitability should be evaluated in consultation with a tax or financial advisor.
Given the structure of DSTs, where only the sponsor is allowed to make decisions regarding the underlying assets, these investments typically involve limited day-to-day involvement from investors. For individuals looking to reduce active management responsibilities, DSTs can offer a more passive ownership experience. This structure is often considered by those transitioning into retirement or seeking lower-maintenance real estate exposure.
DSTs can usually own institutional-grade assets thanks to the substantial funds pooled by investors. As such, one DST can hold these large properties across multiple industries and across the country. This broader exposure may help reduce geographic concentration risk and provide access to asset classes that can be difficult to acquire individually.
DSTs are not as liquid as stocks, but they may offer more flexibility than directly owned real estate. For example, you can allocate smaller portions of your capital to more DSTs, potentially reducing concentration in a single asset. There’s also the fact that DSTs have a set holding period, usually five to seven years. While early liquidity is limited, the defined term may allow investors to plan ahead for anticipated liquidity events.
DSTs are pre-packaged investments. This feature may assist with identifying replacement properties in a 1031 exchange, a step that is limited to just 45 days. Because DSTs are typically structured to meet IRS requirements, they can often be acquired relatively quickly, offering convenience when timing is a consideration.
Dividing traditional real estate among your heirs can prove difficult. Valuation can present challenges, and the children can fight amongst themselves if one feels that they’re getting the short end of the stick. If these disputes remain unresolved, a forced sale can occur. DST interests, by contrast, can be divided and transferred. You can assign proportional shares to each heir, leading to a more straightforward path for passing on wealth.
Considerations and Risks
While DSTs can offer benefits such as passive ownership and access to diversified real estate, they are not without risks. Investors should be aware that DSTs are generally illiquid, offer limited control over management decisions, and may be affected by fluctuations in property values, market conditions, or tenant performance. Additionally, because DSTs are typically long-term investments with fixed holding periods, early exits are rarely available. As with any investment, the suitability of a DST should be evaluated in the context of an investor’s financial goals, risk tolerance, and time horizon, with guidance from qualified tax and financial professionals.
Investors seeking additional diversification may consider incorporating DSTs into their portfolios. However, some may find them particularly convenient. For example, a retiring landlord looking to exit active management may consider this type of investment suitable for their needs. Those engaged in estate planning may also find DSTs useful for facilitating estate settlement.
DSTs are commonly considered by investors participating in 1031 exchanges, as they can help satisfy like-kind requirements while offering passive ownership. Completing a cycle with a DST can eliminate the need for active management while continuing to defer capital gains taxes, in accordance with IRS rules. Investors may also reinvest in other DSTs in future exchanges as part of a broader wealth preservation strategy. As always, investors should consult with a qualified tax or legal advisor to determine whether this approach aligns with their individual goals.
Investors looking to diversify their real estate portfolios may consider DSTs as a potential complement to direct ownership. These investments offer flexibility, access to new markets, and a passive ownership structure that may help balance portfolios concentrated in actively managed real estate. When paired with 1031 exchanges, DSTs can also support tax deferral strategies under current IRS guidelines.
With proper planning and professional guidance, DSTs may play a role in building a diversified and tax-efficient portfolio.
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.
Article written by: Story Amplify. Story Amplify is a marketing agency that offers services such as copywriting across industries, including financial services, real estate investment services, and miscellaneous small businesses.
Sources:
https://smartasset.com/investing/delaware-statutory-trusts-dsts
https://www.irs.gov/pub/irs-drop/rr-04-86.pdf
https://smartasset.com/investing/delaware-statutory-trusts-dsts https://www.irs.gov/pub/irs-news/fs-08-18.pdf