Real estate investors are frequently attracted to the potential benefits of commercial property but may lack the individual resources to buy the assets they want. As a result, these investors may pool their capital with other investors to gain access to more substantial properties to achieve their goals. One way to accomplish this is through the structure of a partnership, often a real estate limited partnership.
Partnerships may take various forms. A common approach is a limited partnership. In this structure, there is usually one general partner and that person or entity is responsible for managing the general operations of the partnership. These duties may include identifying target assets, negotiating financing, and working with tenants. The remaining partners contribute capital and share in any profits but do not typically get involved with operations.
Furthermore, each limited partner is only liable for their investment amount, while the general partner is liable for all obligations. Therefore, as an investor, it's vital for you to have confidence in the general partner's abilities.
Partnerships can also be general, in which case each investor contributes to the partnership's daily management and decision-making process. Whether limited or general, the partnership is a pass-through entity, meaning that each partner pays taxes on their share of the partnership income, which is reported to the IRS on Form 1065.
A Delaware Statutory Trust (DST) is typically created and managed by a Sponsor, an entity incorporated in Delaware under the Delaware Statutory Trust Act. This legal framework allows greater legal protection, flexibility, and contractual freedom than common law trusts. While the property owned by a DST does not need to be in Delaware, the DST will need one Delaware-based trustee.
The DST sponsor identifies and acquires the property or properties to be included in the trust. The sponsor also manages the properties, often through a master tenant. DSTs may have high management fees, and it’s critical for potential investors to assess the sponsor's experience and success.
The ability to exchange one property for another without paying capital gains taxes is significant for investors. Investors may be able to accomplish this by using a 1031 exchange to dispose of one property and replace it with another, reinvesting the entire proceeds. A foundational requirement for executing a 1031 exchange is that the entity must remain constant. So, an individual can exchange one property for another, or a partnership can do so. Still, an individual can’t relinquish a property that they replace with a stake in a partnership.
On the other hand, an individual investor can complete a 1031 exchange by moving from direct ownership to participating in a DST. The IRS recognizes the fractional ownership of a DST as direct real estate, enabling taxpayers to transition from active management of individual assets to passive investment in a DST.