A properly structured DST (a legal entity formed under Delaware law, although not necessarily physically in Delaware) will be a grantor trust for the purpose of federal income taxes. That means that participants in such a trust will have undivided fractional interests in the property held by the DST. A grantor trust is one in which the trust creator is considered the owner for income tax and estate taxes.
A grantor trust is always a revocable living trust, as long as the grantor remains alive and the grantor keeps the power to control the assets the trust holds. Usually, these trusts are set up to protect the grantor’s assets and any income generated from the assets so the grantor’s beneficiaries can receive them. Some examples of grantor trusts are spousal access trusts, grantor retained annuity trusts, dynasty trusts, and most irrevocable life insurance trusts, and intentionally defective grantor trusts.
Why Does a DST Qualify as a Grantor Trust?
With a Delaware Statutory Trust, the investors are the beneficiaries, and the sponsor is the grantor. The DST holds the title to the properties in the trust. To meet the requirements for recognition as a grantor trust, the DST must:
- Not purchase additional assets after formation.
- Not receive additional capital.
- Not renegotiate leases or loans.
- Not sell a property and reinvest proceeds.
- Distribute all cash flow to beneficiaries.
How Does a DST Work?
A DST is a complex financial investment that may allow investors to acquire fractional ownership of property they would not have access to as individuals. The DST sponsor develops a plan for building a portfolio of assets, which may focus on a specific sector or asset class. Then, the sponsor offers shares to investors. The investors are eligible to receive shares of potential income as a percentage of their investment. It is important to note that DST ownership is a passive participation, and the shareholders do not exercise any control over the property decisions. The sponsor typically has a master tenant that oversees the properties and works with the subtenants.
One attractive aspect of the DST structure is that they are designed to be 1031 exchange-eligible on entry and departure for investors. They have the potential to also provide tax-advantaged income to participants. Since DST offerings are "off-the-shelf," an investor looking for a replacement property for a 1031 exchange may be able to use this type of investment to reliably meet the timeline to satisfy the IRS requirements and maintain the deferral of capital gains on a relinquished property.
What Are the Potential Downsides of a DST Investment?
All investments have risks. DSTs must be considered illiquid, with typical holding periods of five to ten years. Some investors are uncomfortable with the inability to have effective input into the decisions made by sponsors. In addition, market conditions and unanticipated issues with the properties can negatively impact the investment's cash flow and long-term results.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation. The actual amount and timing of distributions paid by programs is not guaranteed and may vary. There is no guarantee that investors will receive distributions or a return of their capital.