Trusts are widely used in estate planning, and some types of trusts have added characteristics that make them advantageous for investors. One of these categories is the Delaware Statutory Trust (DST), which came to be thanks to the Delaware Statutory Trust Act (DSTA). This piece of legislation provided a legal structure that offers flexibility, liability protection, and tax advantages for investors.
Realized 1031 discusses the DST Act further to help investors understand the framework that enables fractional ownership, passive income, and tax-deferral benefits in real estate through trusts. Let’s dive in.
Prior to the development of statutory trust frameworks, business trusts were governed largely by common law and varied state-level interpretations. There were a lot of differences between each state, and there was no consistent definition of the rights and duties of the parties involved. Then, in 1988, the Delaware legislature created the Delaware Business Trust Act to provide structure and clarity for such legal entities. Thanks to this act, it has become possible for investors to potentially benefit from a standardized and well-defined framework for trust agreements and investment activities.
The law’s introduction was timely. In the decades that followed, the financial industry saw an increasing need for more flexible and investor-friendly structures for pooling capital and managing assets. Eventually, the law would be renamed the Delaware Statutory Trust Act in 2002.
At the most fundamental level, the DST Act serves as a legal framework for the creation of DSTs. The act provided language that defines the characteristics, governance, and legal recognition of DSTs as business trust entities. Key structural features supported by the DSTA include:
The DST Act allowed beneficial interests to be divided among multiple investors — fractional ownership, in other words. This act allowed investors to pool capital and make it easier to invest in large-scale or institutional-grade assets. The act also allows the transfer of beneficial interests without requiring retitling of the underlying property, though restrictions may apply as outlined in the offering documents.
Another feature of the DST Act is that it allowed the DST to become a pass-through entity. This feature helps avoid double taxation (corporate and personal levels). DSTs are generally treated as grantor trusts for tax purposes, which means income, deductions, and gains pass directly to investors without being taxed at the trust level.
Investors in a DST, known as beneficial owners, are generally shielded from personal liability for the debts and obligations of the trust. Their risk is typically limited to the amount they invested, similar to shareholders in a corporation or members of an LLC.
One more feature of the DST Act is how it removed the need for beneficial owners’ involvement in day-to-day operations. Instead, the sponsor takes responsibility for the administration, decision-making, and management of the DST property.
These features have contributed to the growing use of DSTs in real estate investment strategies, particularly among accredited investors pursuing passive income and tax deferral via Section 1031 exchanges.
While not an amendment, Revenue Ruling 2004-86 affirmed that a properly structured Delaware Statutory Trust (DST) can qualify as a “like-kind” replacement property. This ruling enabled investors to defer capital gains taxes by acquiring beneficial interests in a DST through a 1031 Exchange. The DST must meet certain conditions—such as passive investor ownership and limited powers of the trustee—to maintain compliance. The capital gains taxes from the sale will remain deferred until a taxable event occurs.
In the recent decade, there have been additional amendments to the DST Act. The 2016 amendments further enhanced the DSTA.A significant change allowed for the formation of a statutory trust under the DSTA that is not a separate legal entity if explicitly stated in its governing instrument and certificate of trust. The intention behind this was to allow a DST to be treated more like a common law trust for federal and state law and regulatory purposes, while still benefiting from the advantages of the DSTA.
Another significant change came during the 2019 legislative year. Section 3343 of Title 12 enabled the appointment of multiple successors and additional trustees with the authority to allocate specific duties among them. This amendment allowed for greater flexibility in trust administration by permitting the distribution of trustee responsibilities according to the trust’s needs.
Another set of amendments was enacted in 2022 and 2023. These updates include provisions for business development companies and safe harbor language for ratifying defective acts. One significant amendment was the approval of the electronic signature authorization, marking the integration of modern technology in the DST process. Previously, beneficial interest certificates could only be manually signed.
The DST Act is a foundational piece of legislation that governs the creation of DSTs. Thanks to the framework the law provided, as well as amendments that further provided clarity and flexibility, DSTs are a vehicle for fractional ownership in real estate, among accredited investors participating in Section 1031 exchanges..
For those who’d like to enter DSTs as part of their investment strategy, understanding the DST Act can help you navigate the complex process and regulations.
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.
Cited Sources:
https://delcode.delaware.gov/title12/c038/sc01/
https://www.irs.gov/pub/irs-drop/rr-04-86.pdf
https://www.bayardlaw.com/insights/delaware-statutory-trust-amendments-signed-into-law
https://law.justia.com/codes/delaware/title-12/chapter-33/section-3343/
https://www.rlf.com/the-2022-amendments-to-the-delaware-statutory-trust-act/